Abstract
Moral hazard is traditionally analyzed as a bilateral principal–agent problem. In financial markets, however, intermediaries (agents) investing on behalf of clients (principals) must also compete with one another when trading, creating an interaction between incentives and market clearing. I develop a model to study how frictions from moral hazard and imperfect competition interact. Greater competition can reduce welfare by tightening incentive constraints, contradicting the standard prediction that more traders improve efficiency. Using trade data from Canadian exchanges, I show that the model can be used to assess the relative importance of moral hazard and its interaction with competition in practice, highlighting the empirical relevance of the theoretical welfare results.