Bounded Rationality in Principal-Agent Relationships

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may Abstract:We conducted six treatments of a standard moral hazard experiment with hidden action. All treatments had identical Nash equilibria. However, the behavior in all treatments and periods was inconsistent with established agency theory (Nash equilibrium). In the early periods of the experiment, behavior differed significantly between treatments. This difference largely vanished in the final periods. We used logit equilibrium (LE) as a device to grasp boundedly rational behavior and found the following: (1) LE predictions are much closer to subjects' behavior in the laboratory; (2) LE probabilities of choosing between strategies and experimental behavior show remarkably similar patterns; and (3) profit-maximizing contract offers according to the LE are close to those derived from regressions.JEL Classification: C72, C92, J31, L14 Keywords: experiment, logit equilibrium, moral hazard, hidden action Version: January 5, 2012 Moral hazard with hidden action as an established theory in microeconomicsAgency problems have been analyzed theoretically in the last three decades under a variety of conditions, beginning with the studies of Ross (1973), Holmstrom (1979), andShavell (1979). Standard theory postulates that the principal and the agent individually behave rationally, i.e., they have self-centered preferences and maximize expected utility. In the case of hidden action, after signing a contract, the agent takes an action or chooses an effort on behalf of the principal. The effort cannot be observed by the principal. A higher effort of the agent is associated with a higher expected outcome that accrues to the principal and results in higher effort costs for the agent. Since the outcome is exposed to risk, the principal cannot deduce the agent's effort ex post. Therefore, the asymmetric information with regard to the agent's effort induces the well-known moral hazard problem. The agent can choose an inefficiently low level of effort that the principal is unable to detect. Another version of the moral hazard problem arises when the agent's effort is not verifiable by a third party responsible for the enforcement of the contract between principal and agent. Again, the principal cannot force the agent to choose the efficient level of effort. The source of the moral hazard problem is not the stochastic outcome; rather, it is the non-enforceability of contractual agreements based on effort choice. 2To mitigate or even p...

Principal-agent problems in implementation of Ghana’s health insurance scheme

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