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Optimal Contracts with a Risk-Taking Agent

Abstract

Consider an agent who can costlessly add mean-preserving noise to his output. To deter such risk-taking, the principal optimally offers a contract that makes the agent's utility concave in output. If the agent is risk-neutral and protected by limited liability, optimal incentives are strikingly simple: linear contracts maximize profit. If the agent is risk averse, we characterize the unique profit-maximizing contract and show how deterring risk-taking affects the insurance-incentive tradeoff. We extend our model to analyze costly risk-taking and alternative timings, and reinterpret our model as a dynamic setting in which the agent can manipulate the timing of output.

Type

Working Paper

Author(s)

Daniel Barron, George Georgiadis, Jeroen Swinkels

Date Published

2017

Citations

Barron, Daniel, George Georgiadis, and Jeroen Swinkels. 2017. Optimal Contracts with a Risk-Taking Agent.

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