The prevailing theme in hidden action models has long been the conflict between insurance and incentives. According to this theme, a completely insured worker lacks the incentive to exert costly effort, which benefits the employer and which is not contractible. On the other hand, a worker whose wage fully depends on noisy output, has to cope with uncertainty, which he or she dislikes. The desire of the employer to induce effort and the demand of the worker to be insured need to be balanced. As a result, a compromise is found and the worker is partially insured.
KeywordsObjective Function Firm Performance Maximum Likelihood Estimator Asymptotic Normality Incentive Scheme
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