Flexible contracts

This paper studies the costs and bene?ts of delegating decisions to superiorly informed agents, that is of adopting ?exible contracts, relative to the use of rigid, non discretionary contracts. The main focus of the paper lies in the analysis of the costs of delegation, primarily agency costs, versus their bene?ts, primarily the ?exibility of the action choice in two di?erent environments, one with risk and one with ambiguity. We ?rst determine and characterize the properties of the optimal ?exible contract. We then show that the higher the agent’s degree of risk aversion, the higher is the agency costs of delegation and the less pro?table a ?exible contract relative to a rigid one. When the parties have imprecise probabilistic beliefs, the agent’s degree of imprecision aversion introduces another agency cost, which again reduces the relative pro?tability of ?exible contracts.