Moral Hazard with Limited Liability: The Random-Variable Formulation and Optimal Contract Structures

Author:International Office     Date:2016-12-06

Lecturer:Wenbin Wang

Date: 9:30—11:00 2thDec.2016

Venue: Room 102, 3rd Teaching Building

Language: English

 

About the Lecture
We consider an important category of agency models: the moral hazard problem between a principal and an agent with limited liability. We introduce a new way of formulating the model, where the contract design problem reduces to a problem of constructing the distribution function of a random variable. This formulation allows to directly balance the central tradeoff in the agency problem: maximizing the principal’s payoff as well as incentivizing the agent to exert effort or take proper risk.

Several structural results are established about the optimal contracts. We demonstrate the limitation of the standard first-order-approach in solving the moral hazard problems. We are the first to report that the optimal contract may involve two tiers of performance-based bonuses. In regard to the widely used single bonus contract, we obtain new sufficient conditions for its optimality and provide new insights about setting the bonus-triggering threshold and bonus size.

 

About the Lecturer

Wenbin Wang is an Associate Professor of Operations Management at the School of International Business Administration, Shanghai University of Finance and Economics. His research interests lie in two areas. The first area can be labeled as sustainable operations with adaptation to energy markets, and it is mainly concerned with optimizing a firm’s technology and capacity investment choices so that the firm gains the ability to operate sustainably when faced with highly volatile energy prices. The second area of interest is related to inter-firm contracting in the presence of limited financial liability. One of the main challenges in this stream is to solve contract design problem with asymmetric information and limited liability in practical settings where the existing economic method may not directly apply. Wenbin’s teaching interests include supply chain management, sustainable operations and contract theory. He received his Ph.D. in Operations Management and Decision Science from Kelley School of Business at Indiana University in 2012. He received a B.E. degree in Computer Science from Shanghai Jiaotong University.


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