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Contracting In Vague Environments

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  • Marie-Louise Viero

    (Queen's University)

Abstract

This paper shows that a new trade-off arises in the optimal contract when contracting takes place with vague information (objective ambiguity), reflecting that real-world contracting often takes place under imprecise information. The choice-theoretic framework captures a decision-maker`s attitude towards vagueness by his optimism. The new trade-off is between (a) incentive provision and (b) exploitation of heterogeneity that arises endogenously because of the vague environment. Consequently, the optimal contract may distort effort in order to relax incentive compatibility and fully exploit the endogenously created heterogeneity, even when the agent is risk neutral and there is no insurance need in the relationship.

Suggested Citation

  • Marie-Louise Viero, 2006. "Contracting In Vague Environments," Working Paper 1106, Economics Department, Queen's University.
    • Handle: RePEc:qed:wpaper:1106
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    File URL: https://www.econ.queensu.ca/sites/econ.queensu.ca/files/qed_wp_1106.pdf
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    References listed on IDEAS

    as
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    Citations

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    Cited by:

    1. Giraud, Raphaël & Thomas, Lionel, 2017. "Ambiguity, optimism, and pessimism in adverse selection models," Journal of Economic Theory, Elsevier, vol. 171(C), pages 64-100.
    2. Qi Liu & Lei Lu & Bo Sun, 2017. "Incentive Contracting Under Ambiguity Aversion," International Finance Discussion Papers 1195, Board of Governors of the Federal Reserve System (U.S.).
    3. Swagata Bhattacharjee, 2019. "Dynamic Contracting for Innovation Under Ambiguity," Working Papers 1022, Ashoka University, Department of Economics, revised Aug 2019.
    4. Chollete, Lorán & de la Peña, Victor & Klass, Michael, 2023. "The price of independence in a model with unknown dependence," Mathematical Social Sciences, Elsevier, vol. 123(C), pages 51-58.
    5. Marie-Louise Viero, 2006. "Exactly What Happens After The Anscombe-aumann Race? Representing Preferences In Vague Environments," Working Paper 1094, Economics Department, Queen's University.
    6. Hrabrin Bachev, 2013. "Risk Management in the Agri-food Sector," Contemporary Economics, University of Economics and Human Sciences in Warsaw., vol. 7(1), March.
    7. Bhattacharjee, Swagata, 2022. "Dynamic contracting for innovation under ambiguity," Games and Economic Behavior, Elsevier, vol. 132(C), pages 534-552.
    8. Mingli Zheng & Chong Wang & Chaozheng Li, 2016. "Insurance Contracts with Adverse Selection When the Insurer Has Ambiguity about the Composition of the Consumers," Annals of Economics and Finance, Society for AEF, vol. 17(1), pages 179-206, May.
    9. Christian Kellner, 2017. "The principal-agent problem with smooth ambiguity," Review of Economic Design, Springer;Society for Economic Design, vol. 21(2), pages 83-119, June.
    10. Qi Liu & Lei Lu & Bo Sun, 2018. "Incentive contracting under ambiguity aversion," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 66(4), pages 929-950, December.

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    More about this item

    Keywords

    contracts; vagueness; optimism; pessimism; incentives; objective ambiguity;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D20 - Microeconomics - - Production and Organizations - - - General
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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