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Optimal contracts when the players think different

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  • Dumav, Martin
  • Khan, Urmee
  • Rigotti, Luca

Abstract

In a moral hazard model with heterogeneous beliefs, we show that the efficient risksharing contract does not result in a constant wage and the optimal first-best contract may not be increasing in output. When actions are unobservable, heterogeneity in beliefs implies that the monotone likelihood ratio ranking does not ensure that the wage scheme in the optimal contract is non-decreasing in output. This is because differences in beliefs may affect the incentive provision in a non-monotone way. The standard monotonicity result with common beliefs extends to belief heterogeneity when the agent is more optimistic than the principal. Yet, in the reverse case, the optimal contract can be non-monotone.

Suggested Citation

  • Dumav, Martin & Khan, Urmee & Rigotti, Luca, 2023. "Optimal contracts when the players think different," UC3M Working papers. Economics 38519, Universidad Carlos III de Madrid. Departamento de Economía.
    • Handle: RePEc:cte:werepe:38519
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    References listed on IDEAS

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    1. Ying Fan & A. Yeşim Orhun & Dana Turjeman, 2020. "Heterogeneous Actions, Beliefs, Constraints and Risk Tolerance During the COVID-19 Pandemic," NBER Working Papers 27211, National Bureau of Economic Research, Inc.
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    6. 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.
    7. Lopomo, Giuseppe & Rigotti, Luca & Shannon, Chris, 2011. "Knightian uncertainty and moral hazard," Journal of Economic Theory, Elsevier, vol. 146(3), pages 1148-1172, May.
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    10. Auster, Sarah, 2013. "Asymmetric awareness and moral hazard," Games and Economic Behavior, Elsevier, vol. 82(C), pages 503-521.
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    Cited by:

    1. Nikolaj Niebuhr Lambertsen, 2025. "Exploiting overconfidence: optimal contracts with heterogeneous beliefs," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 79(4), pages 1225-1254, June.
    2. 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.
    3. de la Rosa, Leonidas Enrique & Lambertsen, Nikolaj Niebuhr, 2025. "Overconfidence and moral hazard without commitment," Journal of Mathematical Economics, Elsevier, vol. 119(C).

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    Keywords

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    JEL classification:

    • 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
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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