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Journal ArticleDOI

Limited Liability Contracts between Principal and Agent

01 Feb 1983-Journal of Economic Theory (Academic Press)-Vol. 29, Iss: 1, pp 1-21
TL;DR: In this article, the optimal strategy of the principal is examined in an environment where there are (ex post ) limitations on the maximum penalty that can be imposed on a risk-neutral agent.
About: This article is published in Journal of Economic Theory.The article was published on 1983-02-01 and is currently open access. It has received 556 citations till now. The article focuses on the topics: Strict liability & Principal (commercial law).
Citations
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Posted Content
TL;DR: The authors constructs a simple neoclassical model of intrinsic business cycle dynamics in which borrowers' balance sheet positions play an important role and shows that the agency costs of undertaking physical investments are inversely related to the entrepreneur's/borrower's net worth.
Abstract: This paper constructs a simple neoclassical model of intrinsic business cycle dynamics in which borrowers' balance sheet positions play an important role. The critical insight is that the agency costs of undertaking physical investments are inversely related to the entrepreneur's/borrower's net worth. As a result, accelerator effects on investment emerge: Strengthened borrower balance sheets resulting from good times expand investment demand, which in turn tends to amplify the upturn; weakened balance sheets in bad times do just the opposite. Further, redistributions or other shocks that affect borrowers' balance sheets (as in a debt-deflation} may have aggregate real effects.

4,286 citations

Posted ContentDOI
TL;DR: The authors developed a simple neoclassical model of the business cycle in which the condition of borrowers' balance sheets is a source of output dynamics, and the mechanism is that higher borrower net worth reduces the agency costs of financing real capital investments.
Abstract: This paper develops a simple neoclassical model of the business cycle in which the condition of borrowers' balance sheets is a source of output dynamics. The mechanism is that higher borrower net worth reduces the agency costs of financing real capital investments. Business upturns improve net worth, lower agency costs, and increase investment, which amplifies the upturn; vice versa, for downturns. Shocks that affect net worth (as in a debt-deflation) can initiate fluctuations. Copyright 1989 by American Economic Association.

3,795 citations

Journal ArticleDOI
TL;DR: In this paper, the authors model economic development as a process of institutional transformation by focusing on the interplay between agents' occupational decisions and the distribution of wealth, and demonstrate the robustness of this result by extending the model dynamically and studying examples in which initial wealth distributions have long-run effects.
Abstract: This paper models economic development as a process of institutional transformation by focusing on the interplay between agents' occupational decisions and the distribution of wealth. Because of capital market imperfections, poor agents choose working for a wage over self-employment, and wealthy agents become entrepreneurs who monitor workers. Only with sufficient inequality, however, will there be employment contracts; otherwise, there is either subsistence or self-employment. Thus, in static equilibrium, the occupational structure depends on distribution. Since the latter is itself endogenous, we demonstrate the robustness of this result by extending the model dynamically and studying examples in which initial wealth distributions have long-run effects. In one case the economy develops either widespread cottage industry (self-employment) or factory production (employment contracts), depending on the initial distribution; in the other example, it develops into prosperity or stagnation.

2,906 citations

Book
26 Dec 2001
TL;DR: Laffont and Martimort as mentioned in this paper focus on the principal-agent model, the "simple" situation where a principal, or company, delegates a task to a single agent through a contract, the essence of management and contract theory.
Abstract: Economics has much to do with incentives--not least, incentives to work hard, to produce quality products, to study, to invest, and to save. Although Adam Smith amply confirmed this more than two hundred years ago in his analysis of sharecropping contracts, only in recent decades has a theory begun to emerge to place the topic at the heart of economic thinking. In this book, Jean-Jacques Laffont and David Martimort present the most thorough yet accessible introduction to incentives theory to date. Central to this theory is a simple question as pivotal to modern-day management as it is to economics research: What makes people act in a particular way in an economic or business situation? In seeking an answer, the authors provide the methodological tools to design institutions that can ensure good incentives for economic agents. This book focuses on the principal-agent model, the "simple" situation where a principal, or company, delegates a task to a single agent through a contract--the essence of management and contract theory. How does the owner or manager of a firm align the objectives of its various members to maximize profits? Following a brief historical overview showing how the problem of incentives has come to the fore in the past two centuries, the authors devote the bulk of their work to exploring principal-agent models and various extensions thereof in light of three types of information problems: adverse selection, moral hazard, and non-verifiability. Offering an unprecedented look at a subject vital to industrial organization, labor economics, and behavioral economics, this book is set to become the definitive resource for students, researchers, and others who might find themselves pondering what contracts, and the incentives they embody, are really all about.

2,454 citations

Journal ArticleDOI
TL;DR: In this article, the authors developed a model of growth and income inequalities in the presence of imperfect capital markets, and analyzed the trickle-down effect of capital accumulation, showing that when the rate of accumulation is sufficiently high, the economy converges to a unique invariant wealth distribution.
Abstract: This paper develops a model of growth and income inequalities in the presence of imperfect capital markets, and it analyses the trickle-down effect of capital accumulation. Moral hazard with limited wealth constraints on the part of the borrowers is the source of both capital market imperfections and the emergence of persistent income inequalities. Three main conclusions are obtained from this model. First, when the rate of capital accumulation is sufficiently high, the economy converges to a unique invariant wealth distribution. Second, even though the trickle-down mechanism can lead to a unique steady-state distribution under laissez-faire, there is room for government intervention: in particular, redistribution of wealth from rich lenders to poor and middle-class borrowers improves the production efficiency of the economy both because it brings about greater equality of opportunity and also because it accelerates the trickle-down process. Third, the process of capital accumulation initially has the effect of widening inequalities but in later stages it reduces them: in other words, this model can generate a Kuznets curve.

1,559 citations

References
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Journal ArticleDOI
TL;DR: In this article, the role of imperfect information in a principal-agent relationship subject to moral hazard is considered, and a necessary and sufficient condition for imperfect information to improve on contracts based on the payoff alone is derived.
Abstract: The role of imperfect information in a principal-agent relationship subject to moral hazard is considered. A necessary and sufficient condition for imperfect information to improve on contracts based on the payoff alone is derived, and a characterization of the optimal use of such information is given.

7,964 citations


"Limited Liability Contracts between..." refers background in this paper

  • ...The qualitative properties of the zero- ’ A number of authors, including Holmstrom [ 131 and Lewis [ 151, have noted that liability limitations may be important to consider in this context....

    [...]

  • ...To begin with, the fact that the principal must design an incentive scheme for the agent in the absence of complete information about either the true state of nature or the agent’s actions distinguishes (PA) as a “principal-agent” problem as developed by Ross [18, 191, Harris and Raviv [lo, 111, Holmstrom [13], Shave11 [23], and Grossman and Hart [9]....

    [...]

  • ...(See, for example, the works of Ross [18, 191, Harris and Raviv [l I], Holmstrom [13], Hurwicz and Shapiro 1141, and Shave11 [23].)...

    [...]

  • ...(See, for example, the works of Ross [18, 191, Harris and Raviv [l I], Holmstrom [13], Hurwicz and Shapiro 1141, and Shave11 [23]....

    [...]

Journal ArticleDOI
TL;DR: In this paper, the authors make the following simplifying assumptions: (1) Intertemporal problems are ignored; (2) the tax system that would bring about that result would completely discourage unpleasant work; and (3) what such a tax schedule would look like; and what degree of inequality would remain once it was established.
Abstract: you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit organization founded in 1995 to build trusted digital archives for scholarship. We enable the scholarly community to preserve their work and the materials they rely upon, and to build a common research platform that promotes the discovery and use of these resources. For more information about JSTOR, please contact support@jstor.org. 1. INTRODUCTION One would suppose that in any economic system where equality is valued, progressive income taxation would be an important instrument of policy. Even in a highly socialist economy, where all who work are employed by the State, the shadow price of highly skilled labour should surely be considerably greater than the disposable income actually available to the labourer. In Western Europe and America, tax rates on both high and low incomes are widely and lengthily discussed3: but there is virtually no relevant economic theory to appeal to, despite the importance of the tax. Redistributive progressive taxation is usually related to a man's income (or, rather, his estimated income). One might obtain information about a man's income-earning potential from his apparent I.Q., the number of his degrees, his address, age or colour: but the natural, and one would suppose the most reliable, indicator of his income-earning potential is his income. As a result of using men's economic performance as evidence of their economic potentialities, complete equality of social marginal utilities of income ceases to be desirable, for the tax system that would bring about that result would completely discourage unpleasant work. The questions therefore arise what principles should govern an optimum income tax; what such a tax schedule would look like; and what degree of inequality would remain once it was established. The problem seems to be a rather difficult one even in the simplest cases. In this paper, I make the following simplifying assumptions: (1) Intertemporal problems are ignored. It is usual to levy income tax upon each year's income, with only limited possibilities of transferring one year's income to another for tax purposes. In an optimum system, one would no doubt wish …

4,157 citations

Posted Content
TL;DR: The canonical agency problem can be posed as follows as discussed by the authors : the agent may choose an act, aCA, a feasible action space, and the random payoff from this act, w(a, 0), will depend on the random state of nature O(EQ the state space set), unknown to the agent when a is chosen.
Abstract: The relationship of agency is one of the oldest and commonest codified modes of social interaction. We will say that an agency relationship has arisen between two (or more) parties when one, designated as the agent, acts for, on behalf of, or as representative for the other, designated the principal, in a particular domain of decision problems. Examples of agency are universal. Essentially all contractural arrangements, as between employer and employee or the state and the governed, for example, contain important elements of agency. In addition, without explicitly studying the agency relationship, much of the economic literature on problems of moral hazard (see K. J. Arrow) is concerned with problems raised by agency. In a general equilibrium context the study of information flows (see J. Marschak and R. Radner) or of financial intermediaries in monetary models is also an example of agency theory. The canonical agency problem can be posed as follows. Assume that both the agent and the principal possess state independent von Neumann-Morgenstern utility functions, G(.) and U(.) respectively, and that they act so as to maximize their expected utility. The problems of agency are really most interesting when seen as involving choice under uncertainty and this is the view we will adopt. The agent may choose an act, aCA, a feasible action space, and the random payoff from this act, w(a, 0), will depend on the random state of nature O(EQ the state space set), unknown to the agent when a is chosen. By assumption the agent and the principal have agreed upon a fee schedule f to be paid to the agent for his services. T he fee, f, is generally a function of both the state of the world, 0, and the action, a, but we will assume that the action can influence the parties and, hence, the fee only through its impact on the payoff. T his permits us to write,

3,933 citations

Book ChapterDOI
TL;DR: In this article, the authors show that the optimal way of implementing an action by an agent can be found by solving a convex programming problem, and they use this to characterize the optimal incentive scheme and to analyze the determinants of the seriousness of an incentive problem.
Abstract: Most analyses of the principal-agent problem assume that the principal chooses an incentive scheme to maximize expected utility subject to the agent’s utility being at a stationary point. An important paper of Mirrlees has shown that this approach is generally invalid. We present an alternative procedure. If the agent’s preferences over income lotteries are independent of action, we show that the optimal way of implementing an action by the agent can be found by solving a convex programming problem. We use this to characterize the optimal incentive scheme and to analyze the determinants of the seriousness of an incentive problem.

2,743 citations

Book
01 Jan 1972
TL;DR: The Economic Analysis of Law, Eighth Edition as mentioned in this paper provides a comprehensive casebook of the economic analysis of the law, including common law, public regulation of the market, business organizations and financial markets, distribution of income and wealth, the legal process, and the Constitution and the federal system.
Abstract: Economic Analysis of Law, Eighth Edition, written by the pioneer in law and economics analysis, Richard A. Posner, remains the classic text in its field. This lucid, comprehensive casebook covers every aspect of the economic analysis of the law, including the common law, public regulation of the market, business organizations and financial markets, the distribution of income and wealth, the legal process, and the Constitution and the federal system. The Eighth Edition has been substantially revised to take into account current events, including the continuing economic crisis, the re-emerging field of organization economics, and recent work by the author and others on judicial behavior. The this preeminent casebook continues to offer Coverage of the legal-economic perspective on all key areas, from common law to the constitution. Accessible, lucid, and user-friendly writing and organization: Non

2,433 citations