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Subjective evaluation, ambiguity and relational contracts

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  • Brigitte Godbillon-Camus

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    (Laboratoire de Recherche en Gestion et Economie, Institut d'Etudes Politiques, Strasbourg)

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    Abstract

    The current theoretical literature on contracts with compensation system based on subjective performance measures (Prendergast [1999]) which deals with the principal-agent relationship with moral hazard, assumes that these measures have the advantage of giving a more comprehensive view of the agent's performance but the disadvantage of being impossible to verify by a third party. However, the vagueness of the subjective evaluations is not considered. This paper introduces therefore this characteristic of the subjective performance measure of being vague for the agent. To formalize this vagueness, we add to the basic agency model the assumption that there are several signals available as subjective measure and that the agent does not receive enough information to form a unique prior on the set of signals. Hence the agent has ambiguous beliefs on principal's reference signal. We show then that the efficiency and credibility properties of the combination of formal and relational contracts, with the formal contract based on objective evaluations and the relational contract based on subjective evaluations, are no longer satisfied and depend on the agent’s behavior with regard to ambiguity.

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    Bibliographic Info

    Paper provided by Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg in its series Working Papers of LaRGE Research Center with number 2003-03.

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    Date of creation: 2003
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    Handle: RePEc:lar:wpaper:2003-03

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    Keywords: Ambiguity; moral hazard; relational contract; subjective evaluation.;

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    1. Gilboa Itzhak & Schmeidler David, 1993. "Updating Ambiguous Beliefs," Journal of Economic Theory, Elsevier, vol. 59(1), pages 33-49, February.
    2. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March.
    3. Baker, George P & Jensen, Michael C & Murphy, Kevin J, 1988. " Compensation and Incentives: Practice vs. Theory," Journal of Finance, American Finance Association, vol. 43(3), pages 593-616, July.
    4. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
    5. Schmeidler, David, 1989. "Subjective Probability and Expected Utility without Additivity," Econometrica, Econometric Society, vol. 57(3), pages 571-87, May.
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    7. Maskin, Eric & Tirole, Jean, 1990. "The Principal-Agent Relationship with an Informed Principal: The Case of Private Values," Econometrica, Econometric Society, vol. 58(2), pages 379-409, March.
    8. George Baker & Robert Gibbons & Kevin J. Murphy, 1993. "Subjective Performance Measures in Optimal Incentive Contracts," NBER Working Papers 4480, National Bureau of Economic Research, Inc.
    9. Fellingham, John C. & Newman, D. Paul & Suh, Yoon S., 1985. "Contracts without memory in multiperiod agency models," Journal of Economic Theory, Elsevier, vol. 37(2), pages 340-355, December.
    10. George Baker & Robert Gibbons & Kevin J. Murphy, 2002. "Relational Contracts And The Theory Of The Firm," The Quarterly Journal of Economics, MIT Press, vol. 117(1), pages 39-84, February.
    11. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
    12. Pearce, David G. & Stacchetti, Ennio, 1998. "The Interaction of Implicit and Explicit Contracts in Repeated Agency," Games and Economic Behavior, Elsevier, vol. 23(1), pages 75-96, April.
    13. Bull, Clive, 1987. "The Existence of Self-Enforcing Implicit Contracts," The Quarterly Journal of Economics, MIT Press, vol. 102(1), pages 147-59, February.
    14. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
    15. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
    16. Javier M. LÕpez-Cunat, 2000. "Adverse selection under ignorance," Economic Theory, Springer, vol. 16(2), pages 379-399.
    17. Rigotti, L., 1998. "Imprecise Beliefs in a Principal Agent Model," Discussion Paper 1998-128, Tilburg University, Center for Economic Research.
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