Abstract：This note examines the range of applicability of the first-order approach to principal-agent problems under moral hazard. We show the existence of parameter configurations where the solution given by Holmstrom (1979)-Jewitt (1988) stops working to provide the second-best contract. The problem arises when the agent’s reservation utility is below a certain threshold, which is associated with the fact that the contract lacks a fixed component.

Key Words: Moral Hazard; Principal-Agent Model; Second-Best Contract; FirstOrder Approach; Reservation Utility.

http://www.aeconf.com/Articles/Nov2024/aef250208.pdf