The Effects of Risk Aversion on Production Decisions in Decentralized Organizations

This paper presents a principal-agent model in which subsequent to contracting the risk averse agent becomes informed about the production process. Communication of the agent's information is always valuable. The optimal contract given this information asymmetry is characterized by less production and a larger risk premium than when information is symmetric, leading to an efficiency loss. Comparative statics show that the loss in expected production increases as the agent becomes more risk averse.