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Incentives for Unaware Agents

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  • Ernst-Ludwig Von Thadden
  • Xiaojian Zhao

Abstract

The paper introduces the problem of unawareness into principal--agent theory and discusses optimal incentive contracts when the agent may be unaware of her action space. Depending on the agent's default behaviour, it can be optimal for the principal to propose an incomplete contract (that keeps the agent unaware) or a complete contract. The key trade-off is that of enlarging the agent's choice set versus adding costly incentive constraints. If agents differ in their unawareness, optimal contracts show a self-reinforcing pattern: if there are few unaware agents in the economy optimal contracts promote awareness, if unawareness is wide spread optimal contracts shroud the contracting environment, thus keeping the agent unaware. Copyright , Oxford University Press.

Suggested Citation

  • Ernst-Ludwig Von Thadden & Xiaojian Zhao, 2012. "Incentives for Unaware Agents," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(3), pages 1151-1174.
    • Handle: RePEc:oup:restud:v:79:y:2012:i:3:p:1151-1174
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    File URL: http://hdl.handle.net/10.1093/restud/rdr050
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