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Locally robust contracts for moral hazard

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  • Carroll, Gabriel
  • Meng, Delong

Abstract

We consider a moral hazard problem in which the principal has a slight uncertainty about how the agent’s actions translate into output. An incentive contract can be made robust against an ϵ amount of uncertainty, at the cost of a loss to the principal on the order of ϵ, by refunding a small fraction of profit to the agent. We show that as ϵ goes to zero, this construction is essentially optimal, in the sense of minimizing the worst-case loss, among all modifications to the contract that do not depend on the details of the environment.

Suggested Citation

  • Carroll, Gabriel & Meng, Delong, 2016. "Locally robust contracts for moral hazard," Journal of Mathematical Economics, Elsevier, vol. 62(C), pages 36-51.
    • Handle: RePEc:eee:mateco:v:62:y:2016:i:c:p:36-51
    DOI: 10.1016/j.jmateco.2015.11.001
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    References listed on IDEAS

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    1. Philippe Aghion & Drew Fudenberg & Richard Holden & Takashi Kunimoto & Olivier Tercieux, 2012. "Subgame-Perfect Implementation Under Information Perturbations," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 127(4), pages 1843-1881.
    2. Moritz Meyer-ter-Vehn & Stephen Morris, 2012. "The Robustness of Robust Implementation," World Scientific Book Chapters, in: Robust Mechanism Design The Role of Private Information and Higher Order Beliefs, chapter 10, pages 357-373, World Scientific Publishing Co. Pte. Ltd..
    3. Kim-Sau Chung & Jeffrey C. Ely, 2003. "Implementation with Near-Complete Information," Econometrica, Econometric Society, vol. 71(3), pages 857-871, May.
    4. Jehiel, Philippe & Meyer-ter-Vehn, Moritz & Moldovanu, Benny, 2012. "Locally robust implementation and its limits," Journal of Economic Theory, Elsevier, vol. 147(6), pages 2439-2452.
    5. Garrett, Daniel F., 2014. "Robustness of simple menus of contracts in cost-based procurement," Games and Economic Behavior, Elsevier, vol. 87(C), pages 631-641.
    6. Sylvain Chassang, 2013. "Calibrated Incentive Contracts," Econometrica, Econometric Society, vol. 81(5), pages 1935-1971, September.
    7. repec:hal:pseose:hal-00813046 is not listed on IDEAS
    8. repec:hal:pseose:hal-00812781 is not listed on IDEAS
    9. Gabriel Carroll, 2015. "Robustness and Linear Contracts," American Economic Review, American Economic Association, vol. 105(2), pages 536-563, February.
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    Cited by:

    1. 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.
    2. Tinglong Dai & Kinshuk Jerath, 2019. "Salesforce Contracting Under Uncertain Demand and Supply: Double Moral Hazard and Optimality of Smooth Contracts," Marketing Science, INFORMS, vol. 38(5), pages 852-870, September.
    3. Kristóf Madarász & Andrea Prat, 2017. "Sellers with Misspecified Models," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 84(2), pages 790-815.
    4. Pham, Hien & Yamashita, Takuro, 2024. "Auction design with heterogeneous priors," Games and Economic Behavior, Elsevier, vol. 145(C), pages 413-425.
    5. Chi, Wei & Liu, Tracy Xiao & Qian, Xiaoye & Ye, Qing, 2019. "An experimental study of incentive contracts for short- and long-term employees," Journal of Economic Behavior & Organization, Elsevier, vol. 159(C), pages 366-383.
    6. Auster, Sarah, 2018. "Robust contracting under common value uncertainty," Theoretical Economics, Econometric Society, vol. 13(1), January.
    7. Burkett, Justin & Rosenthal, Maxwell, 2024. "Statistical uncertainty and coarse contracts," Journal of Economic Theory, Elsevier, vol. 220(C).

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