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Optimal Contracts under General Mixed Constraints: Continuity, Structure, and Applications

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  • Aggey Simons

    (Department of Economics, University of Ottawa, Canada)

Abstract

This paper characterizes optimal contract structures under adverse selection when the principal faces a general class of mixed (involving allocation and transfer) constraints. We establish conditions for the existence and the continuity of the optimal allocation. We show that under regularity conditions, the optimal continuous contract features at most three distinct regions: segments where the constraint is slack and the allocation follows a modified Baron-Myerson path, alternating with segments where the constraint binds. Assuming non-generic cases are excluded, the binding constraint forces a constant allocation (bunching) over a range of agent types. This framework encompasses a wide range of applications, including enforcement limits, budget constraints, and quality regulations. Our analysis demonstrates how bunching can arise endogenously from optimal design under smooth constraints, distinct from exogenously induced behavioural responses documented empirically.

Suggested Citation

  • Aggey Simons, 2025. "Optimal Contracts under General Mixed Constraints: Continuity, Structure, and Applications," Working Papers 2502E, University of Ottawa, Department of Economics.
    • Handle: RePEc:ott:wpaper:2502e
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    File URL: http://hdl.handle.net/10393/50339
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    More about this item

    Keywords

    Adverse Selection; Optimal Contracts; Mixed Constraints; Endogenous Bunching; Continuity; Allocation Dynamics;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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