Theoretical Economics, Volume 12, Number 1 (January 2017)

Theoretical Economics 12 (2017), 25–51

A unifying approach to incentive compatibility in moral hazard problems

René Kirkegaard


A new approach to moral hazard is presented. Once local incentive compatibility is satisfied, the problem of verifying global incentive compatibility is shown to be isomorphic to the problem of comparing two classes of distribution functions. Thus, tools from choice under uncertainty can be brought to bear to the problem. The approach allows classic justifications of the first-order approach (FOA) to be proven using the same unifying methodology. However, the approach is especially useful for analyzing higher-dimensional moral hazard problems. New and more tractable multi-signal justifications of the FOA are derived and implications for optimal monitoring are examined. The approach yields justifications of the FOA in certain settings where the action is multi-dimensional, as in the case when the agent is multi-tasking. Finally, a tractable multi-tasking model with richer predictions than the popular but simple linear-exponential-normal model is presented.

Keywords: First-order approach, moral hazard, multi-tasking, orthant orders, principal-agent models, stochastic orders

JEL classification: D82, D86

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