Agency conflicts in the presence of random private benefits from project implementation
We study a contracting problem where a principal delegates the decision to implement a "project" to an agent who obtains private information about the value of the project before making the implementation decision. Moral hazard arises because the agent gets private random non-contractible benefits, or incurs private random noncontractible costs, if the project is implemented. This contracting problem is pervasive, when "project" and "benefits" are interpreted broadly. Even when the agent is risk-neutral, we show that the principal's optimal contract always insufficiently discourages the agent from implementing negative NPV projects, and also insufficiently encourages the agent to implement positive NPV projects. We also show that the principal's residual claim always increases in the project's NPV, a result that is generally unobtainable for optimal contracts in effort-based moral hazard problem settings.
Dye, Ronald A. and Swaminathan Sridharan. 2014. Agency conflicts in the presence of random private benefits from project implementation. Economic Letters. 123(3): 308-312.