Knightian uncertainty and moral hazard


Journal Article

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.

Full Text

Duke Authors

Cited Authors

  • Lopomo, G; Rigotti, L; Shannon, C

Published Date

  • May 1, 2011

Published In

Volume / Issue

  • 146 / 3

Start / End Page

  • 1148 - 1172

Electronic International Standard Serial Number (EISSN)

  • 1095-7235

International Standard Serial Number (ISSN)

  • 0022-0531

Digital Object Identifier (DOI)

  • 10.1016/j.jet.2011.03.018

Citation Source

  • Scopus