Disentangling Moral Hazard and Adverse Selection

While many real-world principal-agent problems have both moral hazard and adverse selection, existing tools largely analyze only one at a time. Do the insights from the separate analyses survive when the frictions are combined? We develop a simple method—decoupling—to study both problems at once. Wh...

Full description

Saved in:
Bibliographic Details
Published in:The American economic review 2024-01, Vol.114 (1), p.1-37
Main Authors: Castro-Pires, Henrique, Chade, Hector, Swinkels, Jeroen
Format: Article
Language:English
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:While many real-world principal-agent problems have both moral hazard and adverse selection, existing tools largely analyze only one at a time. Do the insights from the separate analyses survive when the frictions are combined? We develop a simple method—decoupling—to study both problems at once. When decoupling works, everything we know from the separate analyses carries over, but interesting interactions also arise. We provide simple tests for whether decoupling is valid. We develop and numerically implement an algorithm to calculate the decoupled solution and check its validity. We also provide primitives for decoupling to work and analyze several extensions. (JEL D82, D86)
ISSN:0002-8282
DOI:10.1257/aer.20220100