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Ex ante Randomization in Agency Models

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  • John C. Fellingham
  • Young K. Kwon
  • D. Paul Newman

Abstract

We consider how a principal can use randomized strategies in designing optimal contracts in agency settings. We distinguish between ex post randomization (over fee schedules following act selection by the agent) and ex ante randomization (over fee schedules before act selection). We show that ex ante randomization may be efficient in both full information and private information settings under certain assumptions regarding preferences and the production technology. It is particularly significant that additive separability and concavity of the agent's utility function as well as concavity of the production function do not rule out efficient ex ante randomized contracts in private information settings, although, as is known, they rule out ex post randomization.

Suggested Citation

  • John C. Fellingham & Young K. Kwon & D. Paul Newman, 1984. "Ex ante Randomization in Agency Models," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 290-301, Summer.
    • Handle: RePEc:rje:randje:v:15:y:1984:i:summer:p:290-301
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    Cited by:

    1. Brito, Dagobert L. & Hamilton, Jonathan H. & Slutsky, Steven M. & Stiglitz, Joseph E., 1991. "Dynamic optimal income taxation with government commitment," Journal of Public Economics, Elsevier, vol. 44(1), pages 15-35, February.
    2. Macera, Rosario, 2018. "Intertemporal incentives under loss aversion," Journal of Economic Theory, Elsevier, vol. 178(C), pages 551-594.
    3. Kilenthong, Weerachart T. & Townsend, Robert M., 2011. "Information-constrained optima with retrading: An externality and its market-based solution," Journal of Economic Theory, Elsevier, vol. 146(3), pages 1042-1077, May.
    4. Brito, Dagobert L. & Hamilton, Jonathan H. & Slutsky, Steven M. & Stiglitz, Joseph E., 1995. "Randomization in optimal income tax schedules," Journal of Public Economics, Elsevier, vol. 56(2), pages 189-223, February.
    5. Roland Strausz, 2001. "Mitigating Non-Contractability with Interim Randomization," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 157(2), pages 231-245, June.
    6. Kehoe, Timothy J. & Levine, David K. & Prescott, Edward C., 2002. "Lotteries, Sunspots, and Incentive Constraints," Journal of Economic Theory, Elsevier, vol. 107(1), pages 39-69, November.
    7. Anil Arya, 2002. "Synergy among Seemingly Independent Activities," Contemporary Accounting Research, John Wiley & Sons, vol. 19(3), pages 349-363, September.
    8. Lambert, Richard A., 2001. "Contracting theory and accounting," Journal of Accounting and Economics, Elsevier, vol. 32(1-3), pages 3-87, December.

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