TITLE:
On the Consistency of the First-Order-Approach to Principal-Agent Problems
AUTHORS:
Óscar Gutiérrez
KEYWORDS:
Moral Hazard; Principal-Agent Model; First-Order Approach; Likelihood Ratio; Option-Like Incentives.
JOURNAL NAME:
Theoretical Economics Letters,
Vol.2 No.2,
May
23,
2012
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.