| Title | When Risk-Neutral and Risk-Averse Entrepreneurs Work Together: A Different Kind of Support |
|---|---|
| ID_Doc | 66989 |
| Authors | Shahidi, N |
| Title | When Risk-Neutral and Risk-Averse Entrepreneurs Work Together: A Different Kind of Support |
| Year | 2015 |
| Published | |
| Abstract | Businesses that receive entrepreneurial support are likely to have a more sustainable future than businesses that are not supported. In certain situations this support may develop into a longer-term working relationship. For example, a risk-averse entrepreneur may decide to work together with a risk-neutral entrepreneur to reduce his or her risk. This situation can be compared to an insured-insurer relationship in a moral hazard context, in other words wherethe effort made by the risk-averse individual is unobservable by the risk-neutral individual. Perroni and Proto (2010) address this scenario, examining two possible efforts and two states of nature. We generalise the Perroni and Proto (2010) model by considering infinite production states and efforts. In particular, we study the implications of moral hazard when individuals with different risk profiles work together. We assume that the riskier the business, the higher the probability of zero production. If a risk-neutral entrepreneur and a risk-averse entrepreneur enter into a contract to work together, the risk-neutral entrepreneur will make a positive or a zero payment to the risk-averse entrepreneur. In a moral hazard scenario, the contract represents the solution to an optimisation problem between the two entrepreneurs. The risk-neutral entrepreneur maximizes his or her profit under several constraints, the first one beingthe entrepreneurs' individual participation constraints. This means that the risk-averse entrepreneur's utility level under the optimal contract must be greater than his or her utilitywhen there is no contract. The second constraint is the incentive constraint which, as its name indicates, encourages the risk-averse entrepreneur to make the optimal effort. We show that when there is no moral hazard, the optimal contract includes an excess payable by the insured, whichencourages the risk-averse entrepreneur to avoid small losses for which he or she would be responsible. Conversely, in a moral hazard scenario, the optimal contract offered by the risk-neutral entrepreneur to the risk-averse entrepreneur is a type of co-insurance contract that induces the risk-averse entrepreneur to make an effort to avoid majorlosses. |
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