Computation of Moral-Hazard Problems

We study computational aspects of moral-hazard problems. In particular, we consider deterministic contracts as well as contracts with action and/or compensation lotteries, and formulate each case as a mathematical program with equilibrium constraints. We investigate and compare solution properties of the MPEC approach to that of the linear programming (LP) approach with lotteries. We propose a hybrid procedure that combines the best features of both. The hybrid procedure obtains a solution that is, if not global, at least as good as an LP solution. It also preserves the fast local convergence property by applying an SQP algorithm to MPECs. The numerical results on an example show that the hybrid procedure outperforms the LP approach in both computational time and solution quality in terms of the optimal objective value.