Exogenous targeting instruments as a solution to group moral hazards

The ability of four instruments within the general class of exogenous targeting instruments, proposed by Segerson [Journal of Environmental Economic Management 15 (1988) 87], to induce socially optimal outcomes in a group moral hazard environment is investigated in an experiment based on Nalbantian and Schotter [American Economic Review 87 (1997) 314]. Both instruments based on the Holmstrom [Bell Journal of Economics 13 (1982) 324] forcing contract with multiple equilibria, and instruments based on the Segerson study with unique equilibria are tested. My result - that instruments can be designed that mitigate the moral hazard problem at the aggregate level - is a significant advance on the result of Nalbantian and Schotter - that costly monitoring or competitive teams are required to solve the moral hazard problem. It is shown that this result is robust to uncertainty as well as experience. However, none of the instruments insures compliance at the individual level, and as a result hefty fines may be accrued by individuals even when they choose the socially optimal action. (C) 2002 Elsevier Science B.V. All rights reserved.