Robustness and Linear Contracts
American Economic Review · 2015 · Volume 105 · Issue 2
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)
Keywords
Criteria for Decision-Making under Risk and Uncertainty, Asymmetric and Private Information, Mechanism Design, Economics of Contract: Theory
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