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On the Consistency of the First-Order-Approach to Principal-Agent Problems
Universidad Autónoma de Barcelona, Barcelona, Spain
- 1 Universidad Autónoma de Barcelona, Barcelona, Spain
Theoretical Economics Letters·Volume 02 (2012)·Pages 157–161·Published 23 May 2012·DOI10.4236/tel.2012.22028
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Abstract
This paper revisits the principal-agent model with moral hazard when its solution is obtained invoking the first-order-approach. We show that the solution can be economically inconsistent even when “sufficient conditions” ensuring its validity ([1,2]) hold. To be more precise, we provide examples where is impossible to find Lagrange multipliers validating the approach. The correct solution to the problem provides a rationale for option-like contracts and minimum payments.
KeywordsMoral HazardPrincipal-Agent ModelFirst-Order ApproachLikelihood RatioOption-Like Incentives.
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