Risk, Return, and Moral Hazard

The article presents the results of a study that focused on a principal-agent contracting problem in which a manager privately chooses among projects with differing risk-return frontiers and in which the manager's effort choice alters the risk-return frontier of whatever project he selects. The study found that a manager's optimal report about his chosen project's mean is always downward biased and that the extent of this bias increases with the variance of the project's output, the manager's risk-aversion, and the "bonus" portion of the manager's compensation.