Wealth constraint and contractual arrangements

Abstract .  We examine how a project owner optimally selects a project operator and motivates him to deliver an unobservable effort when potential operators are wealth constrained. We show that, when potential operators' abilities are common knowledge, an operator's share of realized profit can be increasing, invariant, or decreasing in his ability depending on the nature of production technology. However, when potential operators are privately informed about both their abilities and their effort supply, a bunching contract arises in equilibrium for a general class of production technology. In the case of bunching, all potential operators are selected equally often and awarded an equal share of realized profit. The finding provides an explanation for the relative uniformity of contract terms in many practical settings.