Limited liability and non-responsiveness in agency models
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This paper analyzes the optimal menu of contracts offered by a risk neutral principal to a risk averse agent under moral hazard, adverse selection and limited liability. We show that a limited liability constraint causes pooling of the most efficient agent types. We also find sufficient conditions under which full-pooling is optimal, regardless of agent‘s risk aversion or type distribution. Our model suggests that offering a single contract is often optimal in environments with moral hazard, adverse selection and in which agents face a limited liability constraint.