Contracting with private rewards

Abstract

I extend the canonical moral hazard model to allow the agent to face endogenous and non-contractible uncertainty. The agent works for the principal and simultaneously pursues private rewards. I establish conditions under which the first-order approach remains valid. The model adds to the literature on intrinsic versus extrinsic motivation. Specifically, to induce higher effort at work the contract may offer higher rewards but flatter incentives. The contract change makes the agent reevaluate his “work-life balance†. Larger employment rewards lessens the incentive to pursue private rewards. The greater reliance on labor income then necessitates weaker explicit incentives to induce high effort.