Chapter 26 Moral hazard This chapter discusses moral hazard. The principalagent relationship embodies a special form of moral hazard which can be called one sided but moral hazard can also be many sided. The paradigmatic model of many sided moral hazard is the partnership in which there are many agents but no principal. The output of the partnership depends jointly on the actions of the partners and on the stochastic environment; each partner observes only the output (and his or her own action) but not the actions of the other partners or the environment. This engenders a free rider problem. As in the case of principalagent relationships a partnership too may last many periods. The chapter presents the principalagent model formally and describes some salient features of optimal principalagent contracts when the relationship lasts a single period. In a large class of cases equilibrium in the one period game is Pareto inefficient. This is a well known problem in providing risk averse agent insurance while simultaneously giving the agent the incentives to take from the principals perspective appropriate actions. The chapter also discusses other properties of static contracts such as monotonicity of the agents compensation in observed profits.