Ugo Bolletta : ugo.bolletta2[at]unibo.it
Mathieu Faure : mathieu.faure[at]univ-amu.fr
Industrial, business and financial catastrophes often have human causes. In order to prevent such outcomes from occurring, governments, business organizations and individuals a priori invest in risk management rules, processes, technologies, and other safeguards aiming to alleviate the effects of human failures. This paper investigates how these investments combine with the incentive systems set afterwards. We find that, in both the first and the second-best, the agent will be fully insured on the downside: her wealth stays the same ex post, whether a bad or a very bad outcome realizes. We also show that the principal's safeguards investment and the agent's effort are strategic substitutes. These conclusions are subject to change, however, depending on current regulatory constraints (such as limited liability, compensation caps or due diligence requirements) and the agent's endowed wealth.