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Robust Incentive Contracts

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Author Info
Wernerfelt, Birger

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Abstract

We look at a principal-agent model in which the agent has to perform an action, the difficulty of which is better known ex interim than ex ante. We compare two contracting regimes; one with commitment to an ex ante negotiated contract, and one with an ex interim negotiated contract. The ex ante contract can not be too steep, but attempts to negotiate a steeper ex interim contract may result in bargaining failure. We find that the relative efficiency of the two contracting regimes depends on the nature of the differences between tasks. In a dynamic version of the analysis, we further find that the comparison depends on the frequency with which new tasks are needed. The argument can be interpreted as an analysis of the tradeoff between weak incentives in the firm and the possibility of unsuccessful negotiations in the market

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File URL: http://hdl.handle.net/1721.1/4052
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Publisher Info
Paper provided by Massachusetts Institute of Technology (MIT), Sloan School of Management in its series Working papers with number 4448-03.

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Date of creation: 13 Feb 2004
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Handle: RePEc:mit:sloanp:4052

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Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), SLOAN SCHOOL OF MANAGEMENT, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA
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Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), SLOAN SCHOOL OF MANAGEMENT, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA

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Related research
Keywords: Theory of the Firm; Employment; Adjustments; Adaptation;

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References listed on IDEAS
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  1. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March. [Downloadable!] (restricted)
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  2. Steven Tadelis, 2002. "Complexity, Flexibility, and the Make-or-Buy Decision," American Economic Review, American Economic Association, vol. 92(2), pages 433-437, May. [Downloadable!]
  3. Birger Wernerfelt, 2002. "Why Should the Boss Own the Assets?," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 11(3), pages 473-485, 09. [Downloadable!] (restricted)
  4. Bajari, Patrick & Tadelis, Steven, 2001. "Incentives versus Transaction Costs: A Theory of Procurement Contracts," RAND Journal of Economics, The RAND Corporation, vol. 32(3), pages 387-407, Autumn.
  5. Jonathan Levin, 2003. "Relational Incentive Contracts," American Economic Review, American Economic Association, vol. 93(3), pages 835-857, June. [Downloadable!]
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  6. Fudenberg, Drew & Holmstrom, Bengt & Milgrom, Paul, 1990. "Short-term contracts and long-term agency relationships," Journal of Economic Theory, Elsevier, vol. 51(1), pages 1-31, June. [Downloadable!] (restricted)
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  7. Holmstrom, Bengt & Milgrom, Paul, 1994. "The Firm as an Incentive System," American Economic Review, American Economic Association, vol. 84(4), pages 972-91, September. [Downloadable!] (restricted)
  8. Myerson, Roger B. & Satterthwaite, Mark A., 1983. "Efficient mechanisms for bilateral trading," Journal of Economic Theory, Elsevier, vol. 29(2), pages 265-281, April. [Downloadable!] (restricted)
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  9. Duncan Simester & Marc Knez, 2002. "Direct and Indirect Bargaining Costs and the Scope of the Firm," Journal of Business, University of Chicago Press, vol. 75(2), pages 283-304, April. [Downloadable!]
  10. Wernerfelt, Birger, 1997. "On the Nature and Scope of the Firm: An Adjustment-Cost Theory," Journal of Business, University of Chicago Press, vol. 70(4), pages 489-514, October. [Downloadable!] (restricted)
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