When Moral Hazard between Principal and Agents Disappear? On Role of Common-Knowledge in a Principal-Agent Model

Takashi Matsuhisa


Issues of moral hazard and adverse selection abound in each and every contract where one has a self interest and information that the other party does not possess. While this is a fertile research area, there is still need for more information on how you handle a party to a contract with more information than you. The Global Financial Crisis is an epitome of the moral hazard: managers and employees (as agents) and shareholders as principals. In fact, still perplexes bankers and shareholders alike: shareholders are still having problems with how they can handle their agents (management), while on the other hand insurers and bankers are struggling to structure products that will reduce the impact of moral hazard. This article re-examines a principal-agent model with moral hazard from the epistemic point of view. It highlights hidden conditions for a possible resolution of the moral hazard between the principal and the agents. In this paper we point out the sharing information as above common-knowledge and communication make a sufficient condition to removing out the moral hazard; that is, we will show that under the same technical assumptions the moral hazard will not have to be disappeared if their expected marginal costs are commonly known or these are fully communicated among the principal and the agents.Keywords: Common-Knowledge, Communication, Principal-Agent Model, Incomplete Information, Moral Hazard, Expected Marginal Costs

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