Contracting with Moral Hazard: A Review of Theory & Empirics

This article surveys the literature on principal-agent problems with moral hazard that gained popularity following the seminal works of Mirrlees (1976), Holmstrom (1979), and others. This literature is concerned with designing incentives to motivate one or more workers—typically by paying for performance—in settings where his actions cannot be directly contracted on. I begin with the canonical framework, and then in Section 2, I categorize the subsequent literature that relaxes various assumptions of this framework. Section 3 focuses on the empirical research, and Section 4 discusses other strands of the literature. My goal is to provide a broad and concise overview-sometimes at the expense of depth, and focus on the economic insights (rather than methodological contributions).