The cost of moral hazard and limited liability in the principal-agent problem
Coauthor(s): Felipe Balmaceda, Santiago Balceiro, José Correa.
In this paper we quantify the potential social-welfare loss due to the existence of limited
liability in the principal-agent problem. The worst-case welfare loss is defined as the largest possible
ratio between the social welfare when the agent chooses the effort that is optimal for the system
and that of the sub-game perfect equilibrium of the game. Our main result establishes that under
the monotone likelihood-ratio property and a limited liability constraint, the worst-case welfare loss
(also known as the Price of Anarchy) is exactly equal to the number of efforts available.
Source: Journal of Economic Theory
Balmaceda, Felipe, Santiago Balceiro, José Correa, and Nicolás Stier-Moses. "The cost of moral hazard and limited liability in the principal-agent problem." Journal of Economic Theory (forthcoming).