Double Moral Hazard,Monitoring, and the Nature of Contracts |
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Authors: | Pradeep Agrawal |
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Institution: | (1) RBI Chair Unit, Institute of Economic Growth, University Enclave, Delhi 110 007, India (e-mail: pradeep@ieg.ernet.in.), IN |
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Abstract: | generalized double-sided moral-hazard model, with risk-averse parties who mutually monitor each other (to get a reasonable idea of outcome/effort).
The model considers trade-off between monitoring costs and moral hazard costs, which are endogenously determined by the extent
of monitoring.
Using this model, we formally prove a generalized version of Coase's conjecture – that the optimal contract minimizes the
agency and risk costs. We then show how varying assumptions about the feasibility or cost of monitoring of the outcome or
the worker's effort lead to different contracts being optimal. The analysis is then used to explain the nature of contracts
observed in practice under many different situations. We will give an explanation as to why industrial workers typically work
under wage contracts, while share contracts are common in agriculture and will explain why profit sharing is more common for
senior managers than for the production workers.
Received September 19, 2000; revised version received October 30, 1997 |
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Keywords: | : contracts double moral hazard incentives monitoring transaction costs risk-premium |
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