We provide a class of counter-examples to existence in a simple moral hazard problem in which the first-order approach is valid. These examples involve utility functions such as ln(w) in which utility diverges to negative infinity at a finite wealth level. In contrast to the Mirrlees example, unbounded likelihood ratios are not needed, and no sequence of contract can approach the full informati...

Several episodes in recent years have highlighted the problem of managers subjecting their firms to large risks. We develop a dynamic moral hazard model where a manager’s diversion of funds is indistinguishable from random shocks. In addition, he also takes unobservable actions which yield certain current payoffs, but expose the firm to large negative shocks. We show that standard pay-for-perfo...

A banking model is constructed where roles for government-provided deposit insurance and discount window lending arise when there are restrictions on branch banking. Banks arise endogenously as an efficient arrangement for sharing risk. Discount window lending permits better risk sharing by making bank assets more liquid, but is limited because of a moral hazard problem which arises from advers...

While the unfolding fi nancial turmoil has involved new elements, more fundamental elements have remained the same. New elements include structured credit, the originate-to-distribute business model and expanded markets for repurchase agreements (repos). The recurrence of crises refl ects a basic procyclicality in the system, which is characterised by a build-up of risk-taking and leverage in g...

We develop a theory of organization design in which the firm’s structure is chosen to mitigate moral hazard problems in the selection and the implementation of projects. For a given set of projects, the “divisional structure” which gives each agent the full responsibility over a subset of projects is in general more efficient than the functional structure under which projects are implemented by...

Competent authorities, healthcare payers and hospitals devote increasing resources to quality management systems but scientific analyses searching for an impact of these systems on clinical outcome remain scarce. Earlier data indicated a stepwise improvement in outcome after allogeneic hematopoietic stem cell transplantation with each phase of the accreditation process for the quality managemen...

The question of when people may impose risks on each other is of fundamental moral importance. Forms of “quantified risk assessment,” especially risk cost-benefit analysis, provide one powerful approach to providing a systematic answer. It is also well known that such techniques can show that existing resources could be usedmore effectively to reduce risk overall. Thus it is often argued that s...

Two policy instruments for the banking sector are investigated, namely systemic risk taxation and constructive ambiguity about bailout policy. Bailout expectations can induce moral hazard in the form of excessive risk taking by banks. Systemic risk taxation induces banks to prefer uncorrelated investments, leading to lower systemic risk formation. Constructive ambiguity generates uncertainty ab...

Risk-sharing in insurance is analyzed, with a view towards explaining the prevalence of deductibles. First we introduce, in a modern setting, the main concepts of the theory of risk-sharing in a group of agents. This theory we apply to the risk-sharing problem between an insurer and an insurance customer. We motivate the development through simple examples, illustrating some of the subtle point...

Risk averse agents who engage in risky production activities frequently participate in some sort of arrangement to share risk. When there are issues of moral hazard, optimal risk sharing typically involves spreading risk over time as well as over space. Agents who suffer bad outcomes can spread risk over time by borrowing against future earnings to supplement present consumption. In this paper ...