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Flexible contracts

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Abstract

This paper studies the costs and benefits of delegating decisions to superiorly informed agents relative to the use of rigid, non discretionary contracts. The main focus of the paper lies in the analysis of the costs of delegation, primarily agency costs, versus their benefits, primarily the flexibility of the action choice. We first determine and characterize the properties of the optimal flexible contract. We then show that the higher the agents's degree of risk aversion, the higher is the agency costs of delegation and the less profitable a flexible contract relative to a rigid one. When the parties to not have sharp probability beliefs, the agent's degree of imprecision aversion introduces another agency cost, which again reduces the relative profitability of flexible contracts

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File URL: ftp://mse.univ-paris1.fr/pub/mse/CES2009/09072.pdf
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Paper provided by Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne in its series Documents de travail du Centre d'Economie de la Sorbonne with number 09072.

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Length: 37 pages
Date of creation: Sep 2009
Handle: RePEc:mse:cesdoc:09072
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Keywords: Delegation; flexibility; agency costs; multiple priors; imprecision aversion;

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Find related papers by JEL classification:
  • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
  • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
  • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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  12. Gajdos, T. & Hayashi, T. & Tallon, J.-M. & Vergnaud, J.-C., 2008. "Attitude toward imprecise information," Journal of Economic Theory, Elsevier, vol. 140(1), pages 27-65, May.
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  18. Ian Jewitt, 1987. "Risk Aversion and the Choice Between Risky Prospects: The Preservation of Comparative Statics Results," Review of Economic Studies, Oxford University Press, vol. 54(1), pages 73-85.
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  20. Mukerji, Sujoy, 1998. "Ambiguity Aversion and Incompleteness of Contractual Form," American Economic Review, American Economic Association, vol. 88(5), pages 1207-1231, December.
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