Guillaume Roger

Moral hazard with random participation

Introduction

Moral hazard with random participation. Studies moral hazard in principal-agent problems with random agent participation due to a stochastic outside option. Finds optimal contracts entail information rents, lower effort, and welfare losses, and screening mechanisms are ineffective.

Abstract

This paper studies a principal-agent problem of moral hazard, in which the outside option is stochastic. This renders the agent's participation decision random from the perspective of the principal. The participation cost is no longer defined in terms of the agent's outside option but in terms of the principal's marginal benefit of participation. The optimal contract (i) entails information rents; (ii) features a trade-off between participation probability and rents and (iii) induces a lower effort than the standard model. Random participation results in weaker incentives and in twofold (ex ante) welfare losses. Menus of contracts (screening mechanisms) are not helpful to extract information because the single-crossing condition does not hold.Keywords: moral hazard, asymmetric information, contract, participation constraint, principal-agent. JEL Classication: D82,D86.

Review

This paper presents a compelling and relevant extension to the classical principal-agent problem of moral hazard by introducing a stochastic outside option for the agent. This innovative feature leads to "random participation" from the principal's perspective, fundamentally altering the traditional contracting environment. The abstract effectively outlines the core problem, its theoretical underpinnings, and its significant implications for optimal contract design, suggesting a departure from standard model outcomes. A major strength of this work lies in its re-conceptualization of the participation cost, shifting its definition from the agent's outside option to the principal's marginal benefit of participation. This reframing is crucial for understanding the paper's subsequent findings. The study adeptly demonstrates that random participation necessitates information rents, introduces a critical trade-off between participation probability and rents, and ultimately, induces lower effort compared to the standard model. The identification of "twofold welfare losses" underscores the significant economic costs associated with this type of uncertainty. Furthermore, the explicit conclusion that menus of contracts (screening mechanisms) are ineffective due to the failure of the single-crossing condition is a powerful and non-obvious result, highlighting a profound challenge in information extraction under these specific conditions. While the abstract provides a compelling summary, a full review would benefit from understanding the specific nature of the stochastic outside option and the precise underlying conditions that lead to the failure of the single-crossing condition. Elaboration on these aspects would solidify the theoretical underpinnings and clarify the generalizability of the results regarding the ineffectiveness of screening. Additionally, while "twofold welfare losses" are mentioned, a more detailed explanation of these two distinct sources of loss would enhance the paper's impact. Finally, a discussion of the practical implications for contract design in real-world scenarios where agents face fluctuating outside opportunities would further enrich the paper's contribution and provide valuable insights for practitioners.

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