Knightian uncertainty and moral hazard |
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Authors: | Giuseppe Lopomo Chris Shannon |
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Institution: | a Fuqua School of Business, Duke University, United States b Department of Economics, University of Pittsburgh, United States c Department of Economics, University of California, Berkeley, United States |
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Abstract: | 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. |
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Keywords: | D82 D81 D23 |
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