Presenter: Nikolaj Niebuhr Lambertsen, AU

Title: Exploiting Overconfidence: Optimal contracts with Heterogeneous Beliefs

Abstract:

I study a principal-agent model with moral hazard and heterogeneous beliefs. Heterogeneous beliefs in the form of overconfidence can completely reverse the fundamental relationship between insurance and incentives. With homogenous beliefs, moral hazard increases the agent’s exposure to risk to ensure that the agent does not perform less than optimal effort. With heterogenous beliefs, moral hazard may decrease the agent’s exposure to risk to ensure that the agent does not perform more than optimal effort. Further, with heterogenous beliefs, using a signal that provides no new information of the agent’s effort may be valuable if it increases disagreement between the principal and the agent. Finally, I provide sufficient conditions for when overconfidence has value, correcting a proof originally proposed by Santos-Pinto (2008), and derive sufficient conditions for when the first-order approach is valid.

Organizers: Stefan Hirth and Anders Merrild Posselt