TEL> Vol.2 No.2, May 2012

On the Consistency of the First-Order-Approach to Principal-Agent Problems

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ABSTRACT

This paper revisits the principal-agent model with moral hazard when its solution is obtained invoking the first-order-approach. We show that the solution can be economically inconsistent even when “sufficient conditions” ensuring its validity ([1,2]) hold. To be more precise, we provide examples where is impossible to find Lagrange multipliers validating the approach. The correct solution to the problem provides a rationale for option-like contracts and minimum payments.

Cite this paper

Ó. Gutiérrez, "On the Consistency of the First-Order-Approach to Principal-Agent Problems," Theoretical Economics Letters, Vol. 2 No. 2, 2012, pp. 157-161. doi: 10.4236/tel.2012.22028.

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