Work

Loss Aversion, Moral Hazard, and Stochastic Contracts

Year: 2024

Type: article

Abstract: ABSTRACT I examine whether stochastic contracts benefit the principal under moral hazard and loss aversion. Incorporating the agent's expectation‐based loss aversion and allowing for stochastic contracts, I find that stochastic contracts reduce the principal's cost as compared with deterministic contracts. The optimal stochastic contract pays a high wage not only when good signals are realized but also with a positive probability after the realization of bad signals. The findings have an important implication for designing contracts for loss‐averse agents: the principal should insure the agent against wage uncertainty by employing stochastic contracts that increase the probability of a high wage.

Source: Managerial and Decision Economics

DOI: 10.1002/mde.4459

Author: Hoa Ho

Institution: Ludwig-Maximilians-Universität München

Language: English

Topic: Decision-Making and Behavioral Economics

Subfield: General Decision Sciences

Field: Decision Sciences

Domain: Social Sciences

Open Access status: hybrid

Estimated APC paid: $2,970

Funder: Deutsche Forschungsgemeinschaft