Robust contracting with additive noise

Gabriel Carroll and Delong Meng

Journal of Economic Theory, 2016, vol. 166, issue C, 586-604

Abstract: We investigate the idea that linear contracts are reliable because they give the same incentives for effort at every point along the contract. We ask whether this reliability leads to a microfoundation for linear contracts, when the principal is profit-maximizing. We consider a principal-agent model with risk neutrality and limited liability, in which the agent observes the realization of a mean-zero shock to output before choosing how much effort to exert. We show that such a model can indeed provide a foundation for reliable contracts, and illustrate what elements are required. In particular, we must assume that the principal knows a lower bound, but not an upper bound, on the shocks.

Keywords: Linear contract; Principal-agent problem; Robustness; Worst-case (search for similar items in EconPapers)
JEL-codes: D81 D82 D86 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:166:y:2016:i:c:p:586-604

DOI: 10.1016/j.jet.2016.10.002

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