Insurance can encourage the use of risk-increasing inputs, but it can also decrease people's incentives to exert effort when it is difficult to monitor how much they exert themselves. This effort reduction can go hand in hand with a decrease in the use of effort-complementary inputs. I study a...

We argue that capital misallocation arises endogenously due to incomplete consumption insurance. We model risk-averse entrepreneurs with heterogeneous productivity who face idiosyncratic output shocks and choose how much capital to rent before uncertainty unfolds. We show that incomplete markets...