Compensation Disparity between Risk Averse Agents under Adverse Selection and Moral Hazard

We extend the LEN moral hazard model to allow for adverse selection and derive the optimal incentive contract menu. We show that both moral hazard and adverse selection separately cause compensation disparity between agents with different degrees of risk aversion. We also show that adverse selection aggravates the compensation disparity when more risk averse agents form a minority of the agent population.

1. INTRODUCTION

2. THE MODEL

3. THE OPTIMAL CONTRACT

4. ANALYSIS OF THE OPTIMAL CONTRACT AND COMPENSATION

5. DISCUSSION AND CONCLUDING REMARKS

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