Robustness and Linear Contracts
American Economic Review
vol. 105,
no. 2, February 2015
(pp. 536-63)
Abstract
We consider a moral hazard problem where the principal is uncertain as to what the agent can and cannot do: she knows some actions available to the agent, but other, unknown actions may also exist. The principal demands robustness, evaluating possible contracts by their worst-case performance, over unknown actions the agent might potentially take. The model assumes risk-neutrality and limited liability, and no other functional form assumptions. Very generally, the optimal contract is linear. The model thus offers a new explanation for linear contracts in practice. It also introduces a flexible modeling approach for moral hazard under nonquantifiable uncertainty. (JEL D81, D82, D86)Citation
Carroll, Gabriel. 2015. "Robustness and Linear Contracts." American Economic Review, 105 (2): 536-63. DOI: 10.1257/aer.20131159Additional Materials
JEL Classification
- D81 Criteria for Decision-Making under Risk and Uncertainty
- D82 Asymmetric and Private Information; Mechanism Design
- D86 Economics of Contract: Theory