Incentives and Risks in Relationships Between the Principal and the Agent

Abstract

The paper addresses a basic model of moral hazard (risk) [Gibbons, 2010; Gibbons, 2005] and suggests some of its modifications. In the basic model of moral risk, questions are put and examined that have not been considered in the previous researches. In particular, it is proved that the level of agent's efforts that maximizes its expected utility coincides with the level of efforts that minimize the risk of obtaining this maximum utility. Modifications of the moral risk model are considered where the optimal behavior of the principal and the agent considerably differ from the respective behavior in the moral risk model.

The paper introduces moral risk measures VaR for the principal and VaR for the agent that specify the qualitative assessments of risk on the part of the principal and the agent in their relationships.