Regulation and altruism

• Author: Samuel Kembou Nzale,Izabela Jelovac
• Date: 01 February 2020
• DOI: http://doi.org/10.1111/jpet.12368
• Published date: 01 February 2020

Received: 30 October 2017

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Accepted: 7 March 2019

DOI: 10.1111/jpet.12368

ORIGINAL ARTICLE

Regulation and altruism

Izabela Jelovac

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Samuel Kembou Nzale

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CNRS, University of Lyon, GATE UMR

5824, Ecully, France

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CNRS, EHESS, Centrale Marseille,

AMSE, Aix‐Marseille University,

Marseille, France

Correspondence

Izabela Jelovac, CNRS, University of

Lyon, GATE UMR 5824, F‐69130 Écully,

Lyon, France.

Email: izabela.jelovac@cnrs.fr

Abstract

We study optimal contracts in a regulator–agent setting

with joint production, altruistic and selfish agents,

limited liability, and uneasy outcome measurement.

Such a setting represents sectors of activities such as

education and healthcare provision. The agents and the

regulator jointly produce an outcome for which they all

care to some extent that is varying from agent to agent.

Some agents, the altruistic ones, care more than the

regulator does while others, the selfish agents, care less.

Moral hazard is present due to both the agent’s effort

and the joint outcome that are not contractible. Adverse

selection is present too since the regulator cannot a

priori distinguish between altruistic and selfish agents.

Contracts consist of a simple transfer from the regulator

to the agents together with the regulator’s input in the

joint production. We show that, under the conditions of

our setting and when we face both moral hazard and

adverse selection, the regulator maximizes welfare with

a menu of contracts, which specify higher transfers for

the altruistic agents and higher regulator’s inputs for the

selfish agents.

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INTRODUCTION

In sectors such as education and healthcare, the measurement of results is uneasy and thus

results hardly influence payments or rewards. Moreover, the outcomes in such sectors often

depend on the contributions of both the agent and the regulator. The agent can be a teacher or a

healthcare provider and she contributes with her professional effort. The regulator represents

the collectivity and he provides inputs such as computers, classrooms, universities, hospitals,

and so forth. Also, the agent and the regulator happen to share the same objectives, at least

partially. A teacher cares for the quality of the education and a physician cares for the quality of

J Public Econ Theory. 2020;22:49–68. wileyonlinelibrary.com/journal/jpet © 2019 Wiley Periodicals, Inc.

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healthcare. The agent and the regulator care for these outcomes to some extent, which is

varying from one agent to another. If an agent cares more than the regulator does, we call her

altruistic. Instead, if she cares less than the regulator does, we call her selfish. This

heterogeneity in agent’s altruism is in line with the empirical evidence reported by Watt,

Richardson, and Wilkins (2014) for teachers and by Brosig‐Koch, Hennig‐Schmidt, Kairies‐

Schwarz, and Wiesen (2017) for physicians. In our setting, the concepts of altruism, mission‐

oriented behavior, professional ethics, or public service motivation are actually equivalent.

In this paper, we analyze optimal contracts in a principal–agent setting with limited liability

that reflects the characteristics of such sectors. The principal (he) is a regulator who cares for

some outcome jointly produced with the agent (she). The agent’s effort and the outcome are not

contractible. Moreover, the agent has private information on her altruism level, that is, on the

extent to which she shares the regulator’s concern for the jointly produced outcome. Therefore,

contracts consist of a transfer from the regulator to the agent and of a regulator’s input in the

joint production. To sum up, we face a problem of moral hazard together with adverse selection.

We derive and analyze the optimal contract in three regimes. We refer to first‐, second‐and

third‐best contracts, respectively, without any agency problem, with moral hazard only and

contracts with moral hazard cum adverse selection. We proceed in this way because it enables

to study progressively how the information asymmetry impacts on the regulator–agent

relationship. With the first‐best contract, regulator’s input, effort, and transfer do not vary with

the altruism level and they are decreasing in the shadow cost of public funds. Altruism does not

affect the first‐best solution because the latter satisfies a binding agent’s limited liability

constraint (LLC), which does not include her altruistic benefits. As long as the solution satisfies

the LLC, it also satisfies the participation constraint, which adds to the former the altruistic

component. The first‐best contract would still be optimal if the only agency problem was

adverse selection. With the second‐best contract, we show that for selfish agents, effort and

transfer increase with altruism and the regulator’s input is invariant to changes in altruism. The

regulator’s input serves as an incentive for a selfish agent’s effort and the transfer exactly

compensates the selfish agent for her personal cost of effort. For the altruistic agents, the

second‐best solution coincides with the first‐best one. The regulator uses the transfer to restrict

the altruistic agent’s effort to the first‐best one. Higher levels of agent’s effort would be too

costly to the regulator because of limited liability. The regulator’s input in turn plays no role as

an incentive for effort, when we consider the second‐best contract for an altruistic agent. Even

so, the effort of an altruistic agent is higher than the one of a selfish agent, and the second‐best

transfer is thus higher for an altruistic agent. If the regulator proposes the second‐best contracts

to the agents without being able to distinguish them according to their degree of altruism, then

the selfish agents would pretend to be altruistic to enjoy the higher transfer designed for

altruistic agents. To avoid such a selection issue, we turn to the third‐best analysis and we

derive separating contracts to maximize welfare. These third‐best contracts specify a higher

transfer for the altruistic agents and a higher regulator’s input for the selfish agent.

An important driver of our results is our modeling of the agent’s participation and LLCs. The

difference between the participation constraint and the LLC is the altruistic part of the agent’s

utility. A classical participation constraint grants the agent a utility that is not lower than a

reservation utility, which we normalize to zero. This classicalparticipation constraint includes the

altruistic component of the agent’s utility. Such a participation constraint appears in the analysis

by Jack (2005). It implicitly assumes that thealtruistic satisfaction of contributing to the outcome

can only be obtained within the principal–agent relationship. It also implicitly assumes that an

altruistic agent is ready to pay to enter the principal–agent relationship. We rather opt for a

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JELOVAC AND KEMBOU NZALE