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Optimal contracts when the players think differently

Author

Listed:
  • Martin Dumav

    (Universidad Carlos III de Madrid)

  • Urmee Khan

    (University of California Riverside)

  • Luca Rigotti

    (University of Pittsburgh)

Abstract

In a canonical moral hazard problem with probabilistic but heterogeneous beliefs, we revisit existing results regarding first-best contracts and give a fair warning regarding the monotonicity of second-best contracts. We show that the standard monotonicity result with homogeneous beliefs extends to belief heterogeneity when the agent is more optimistic than the principal. However, in the reverse case—when the principal is more optimistic—the optimal contract can be non-monotone, breaking the link between compensation and performance.

Suggested Citation

  • Martin Dumav & Urmee Khan & Luca Rigotti, 2025. "Optimal contracts when the players think differently," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 80(3), pages 863-890, November.
    • Handle: RePEc:spr:joecth:v:80:y:2025:i:3:d:10.1007_s00199-025-01646-4
    DOI: 10.1007/s00199-025-01646-4
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    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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