Resolving Double Moral Hazard Problems with Buyout Agreements

Abstract

and the Public Utilities Research Center at the University of Florida is gratefully acknowledged. We consider a double moral hazard problem in which the efforts of two parties, e.g., a principal who initially owns an enterprise and a risk averse agent in the enterprise, are not verifiable. The realized value of the enterprise's random profit stream is also unverifiable. There is also no third party to break a "balanced budget " requirement. Nevertheless, the double moral hazard problem can be resolved completely and costlessly when the principal, who can observe the agent's actions, has the option of requiring the agent to purchase the enterprise at a prenegotiated price. 1. Introduction. It has long been recognized that workers whose wages are not linked to the firm's performance may have limited incentive to work diligently, particularly when observed shirking by an employee. cannot be documented conclusively to any third party (Le., when shirking is not verifiable). Of course, some incentive for workers to labor diligently may be restored if the