Department of Economics and Business Economics

Overconfidence and Moral Hazard

Research output: Contribution to journal/Conference contribution in journal/Contribution to newspaperJournal articleResearchpeer-review

  • School of Economics and Management
In this paper, I study the effects of overconfidence on incentive contracts in
a moral-hazard framework. Agent overconfidence can have conflicting effects on
the equilibrium contract. On the one hand, an optimistic or overconfident agent
disproportionately values success-contingent payments, and thus prefers
higher-powered incentives. On the other hand, if the agent overestimates
the extent to which his actions affect outcomes,
lower-powered incentives are sufficient to induce any given effort level. If
the agent is moderately overconfident, the latter effect dominates. Because
the agent bears less risk in this case, there are efficiency gains stemming
from his overconfidence. If the agent is significantly overconfident, the
former effect dominates; the agent is then exposed to an excessive amount of
risk, and any gains arise only from risk-sharing under disagreement. An increase in
optimism or overconfidence increases the effort level implemented
in equilibrium.
Original languageEnglish
JournalGames and Economic Behavior
Pages (from-to)429 - 451
Publication statusPublished - Nov 2011

    Research areas

  • overconfidence, heterogeneous beliefs, moral hazard

See relations at Aarhus University Citationformats

Download statistics

No data available

ID: 35260680