1993 Reports

Moral Hazard

Radner, Roy; Dutta, Prajit Kumar

"The owner of an enterprise wants to put it in the hands of a manager. The
profits of the enterprise will depend both on the actions of the manager as well as
the environment within which he operates. The owner cannot directly monitor the
agent's action nor can he costlessly observe all relevant aspects of the environment.
This situation may also last a number of successive periods. The owner and the
manager will have to agree on how the manager is to be compensated, and the
owner wants to pick a compensation mechanism that will motivate the manager to
provide a good return on the owner's investment, net of the payments to the
manager. This is the well-known "principal-agent" problem with moral hazard.
Some other principal-agent relationships in economic life are: client-lawyer,
customer-supplier, insurer-insured and regulator-public utility."