Moral Hazard and Efficiency in a Frictional Market

Principals seek to trade with homogeneous agents by posting incen-tive contracts, which direct their search. Search and moral hazard interact in equilibrium. If using transfers to compensate agents fail-ing to contract, the equilibrium allocation is always constrained -wel-fare-optimal in contrast to the one-to-one principal-agent problem. Search frictions thus correct that inefficiency because search requires internalizing the utility of agents. Incentives are weaker than in bilat-eral contracting, and agents enjoy more efficient risk sharing. With a constraint on transfers the allocation may become inefficient; prin-cipal competition results in overinsurance of the agents, too little effort in equilibrium, and excessive entry by principals. (JEL D82, D83, D86)