Knightian uncertainty and moral hazard
This paper presents a principal-agent model in which the agent has imprecise beliefs. We model this situation formally by assuming the agent's preferences are incomplete as in Bewley (1986) [2]. In this setting, incentives must be robust to Knightian uncertainty. We study the implications of robustness for the form of the resulting optimal contracts. We give conditions under which there is a unique optimal contract, and show that it must have a simple flat payment plus bonus structure. That is, output levels are divided into two sets, and the optimal contract pays the same wage for all output levels in each set. We derive this result for the case in which the agent's utility function is linear and then show it also holds if this utility function has some limited curvature. © 2011 Elsevier Inc.
Duke Scholars
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- Economic Theory
- 3803 Economic theory
- 3801 Applied economics
- 1499 Other Economics
- 1401 Economic Theory
Citation
Published In
DOI
EISSN
ISSN
Publication Date
Volume
Issue
Start / End Page
Related Subject Headings
- Economic Theory
- 3803 Economic theory
- 3801 Applied economics
- 1499 Other Economics
- 1401 Economic Theory