Optimal contracts under competition when uncertainty from adverse selection and moral hazard are present

TL;DR

This paper demonstrates that linear contracts remain optimal in continuous-time models with risk-averse agents controlling output, even when reservation utilities vary by type, extending previous results to more complex principal-agent scenarios.

Contribution

It extends the known linearity of optimal contracts to settings with type-dependent reservation utilities in continuous-time models with moral hazard and adverse selection.

Findings

Linear contracts are optimal even with type-dependent reservation utilities.

The result applies to models with competing principals and risk-averse agents.

Optimal contracts depend linearly on terminal output under broader conditions.

Abstract

In a continuous-time setting where a risk-averse agent controls the drift of an output process driven by a Brownian motion, optimal contracts are linear in the terminal output; this result is well-known in a setting with moral hazard and -under stronger assumptions - adverse selection. We show that this result continues to hold when in addition reservation utilities are type-dependent. This type of problem occurs in the study of optimal compensation problems involving competing principals.