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Robust contracting with additive noise

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  • Carroll, Gabriel
  • Meng, Delong

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.

Suggested Citation

  • Carroll, Gabriel & Meng, Delong, 2016. "Robust contracting with additive noise," Journal of Economic Theory, Elsevier, vol. 166(C), pages 586-604.
    • Handle: RePEc:eee:jetheo:v:166:y:2016:i:c:p:586-604
    DOI: 10.1016/j.jet.2016.10.002
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    Cited by:

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    2. Paweł Doligalski & Abdoulaye Ndiaye & Nicolas Werquin, 2023. "Redistribution with Performance Pay," Journal of Political Economy Macroeconomics, University of Chicago Press, vol. 1(2), pages 371-402.
    3. Zhaolin Li & Samuel N. Kirshner, 2021. "Salesforce Compensation and Two‐Sided Ambiguity: Robust Moral Hazard with Moment Information," Production and Operations Management, Production and Operations Management Society, vol. 30(9), pages 2944-2961, September.
    4. Daniel Walton & Gabriel Carroll, 2022. "A General Framework for Robust Contracting Models," Econometrica, Econometric Society, vol. 90(5), pages 2129-2159, September.
    5. Garrett, Daniel F., 2020. "Payoff Implications of Incentive Contracting," TSE Working Papers 20-1140, Toulouse School of Economics (TSE).
    6. Wanchang Zhang, 2021. "Correlation-Robust Optimal Auctions," Papers 2105.04697, arXiv.org, revised May 2022.
    7. Peter Zhang, 2023. "Distributionally Robust Principal-Agent Problems and Optimality of Contracts," Papers 2303.07468, arXiv.org, revised Jan 2024.
    8. Fulghieri, Paolo & Dicks, David, 2021. "Uncertainty, Contracting, and Beliefs in Organizations," CEPR Discussion Papers 15378, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    Linear contract; Principal-agent problem; Robustness; Worst-case;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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