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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
Date of revision:
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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  1. Philippe Aghion & Jean Tirole, 1994. "Normal and Real Authority in Organizations," Working papers 94-13, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Thibault Gajdos & Takashi Hayashi & Jean-Marc Tallon & Jean-Christophe Vergnaud, 2006. "Attitude toward imprecise information," Cahiers de la Maison des Sciences Economiques v06081, Université Panthéon-Sorbonne (Paris 1).
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  8. Alonso, Ricardo & Matouschek, Niko, 2005. "Optimal Delegation," CEPR Discussion Papers 5289, C.E.P.R. Discussion Papers.
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  12. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
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  15. Bruno Jullien & Bernard Salanié & François Salanié, 1999. "Should More Risk-Averse Agents Exert More Effort?," The Geneva Risk and Insurance Review, Palgrave Macmillan, vol. 24(1), pages 19-28, June.
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  23. Peter Klibanoff & Massimo Marinacci & Sujoy Mukerji, 2002. "A smooth model of decision making under ambiguity," ICER Working Papers - Applied Mathematics Series 11-2003, ICER - International Centre for Economic Research, revised Apr 2003.
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