Ambiguity in Dynamic Contracts
I study a dynamic principal agent model in which the effort cost of the agent is unknown to the principal. The principal is ambiguity averse, and designs a contract which is robust to the worst case effort cost process. Ambiguity divides the contract into two regions. After sufficiently high performance, the agent reaches the over-compensation region, where he receives excessive benefits compared to the contract without ambiguity, while after low performance, he enters the under-compensation region. Ambiguity also causes a disconnect between the current effort cost and the strength of incentives. That is, even when the agent is under-compensated, his incentives are as strong as in the over-compensation region, since the principal fears the agent might shirk otherwise. Under ambiguity, the agent’s true effort cost does not need to equal the worst-case. I analyze the agent’s incentives for this case, and show that the possibility of firing is detrimental to the agent’s incentives. I study several extensions concerning the timing structure and the nature of the principal’s ambiguity aversion. JEL Code: D82, D86, M52
|Date of creation:||16 Jan 2012|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://www.kellogg.northwestern.edu/research/math/
More information through EDIRC
|Order Information:|| Email: |
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- repec:oup:restud:v:75:y:2008:i:3:p:957-984 is not listed on IDEAS
- Dirk Bergemann & Karl H Schlag, 2007.
"Pricing without Priors,"
122247000000001557, UCLA Department of Economics.
- Larry Epstein & Martin Schneider, 2006.
"Learning Under Ambiguity,"
RCER Working Papers
527, University of Rochester - Center for Economic Research (RCER).
- Dirk Bergemann & Karl Schlag, 2005.
"Robust Monopoly Pricing,"
Cowles Foundation Discussion Papers
1527R2, Cowles Foundation for Research in Economics, Yale University, revised Sep 2008.
- Dirk Bergemann & Karl Schlag, 2007. "Robust Monopoly Pricing," Levine's Bibliography 321307000000000983, UCLA Department of Economics.
- Dirk Bergemann & Karl Schlag, 2005. "Robust Monopoly Pricing," Cowles Foundation Discussion Papers 1527R, Cowles Foundation for Research in Economics, Yale University, revised Apr 2007.
- Daniel F. Garrett & Alessandro Pavan, 2012.
"Managerial Turnover in a Changing World,"
Journal of Political Economy,
University of Chicago Press, vol. 120(5), pages 879 - 925.
- Zengjing Chen & Larry G. Epstein, 2000.
"Ambiguity, risk and asset returns in continuous time,"
RCER Working Papers
474, University of Rochester - Center for Economic Research (RCER).
- Zengjing Chen & Larry Epstein, 2002. "Ambiguity, Risk, and Asset Returns in Continuous Time," Econometrica, Econometric Society, vol. 70(4), pages 1403-1443, July.
- Brian J. Hall & Kevin J. Murphy, 2003. "The Trouble with Stock Options," NBER Working Papers 9784, National Bureau of Economic Research, Inc.
- Tomasz Piskorski & Alexei Tchistyi, 2011. "Stochastic House Appreciation and Optimal Mortgage Lending," Review of Financial Studies, Society for Financial Studies, vol. 24(5), pages 1407-1446.
- Yahel Giat & Steve T. Hackman & Ajay Subramanian, 2010. "Investment under Uncertainty, Heterogeneous Beliefs, and Agency Conflicts," Review of Financial Studies, Society for Financial Studies, vol. 23(4), pages 1360-1404, April.
- Xavier Gabaix & Augustin Landier, 2006.
"Why Has CEO Pay Increased So Much?,"
2006 Meeting Papers
518, Society for Economic Dynamics.
- Subir Bose & Arup Daripa, 2008.
"A Dynamic Mechanism and Surplus Extraction Under Ambiguity,"
Discussion Papers in Economics
08/24, Department of Economics, University of Leicester.
- Bose, Subir & Daripa, Arup, 2009. "A dynamic mechanism and surplus extraction under ambiguity," Journal of Economic Theory, Elsevier, vol. 144(5), pages 2084-2114, September.
- Subir Bose & Arup Daripa, 2007. "A Dynamic Mechanism and Surplus Extraction Under Ambiguity," Birkbeck Working Papers in Economics and Finance 0716, Birkbeck, Department of Economics, Mathematics & Statistics.
- Daniel Garrett & Alessandro Pavan, 2014. "Dynamic Managerial Compensation: On the Optimality of Seniority-based Schemes," Discussion Papers 1579, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Itzhak Gilboa & David Schmeidler, 1989.
"Maxmin Expected Utility with Non-Unique Prior,"
- Bruno Strulovici & Martin Szydlowski, 2012.
"On the Smoothness of Value Functions,"
1542, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Oyer, Paul & Schaefer, Scott, 2011.
"Personnel Economics: Hiring and Incentives,"
Handbook of Labor Economics,
- repec:nwu:cmsems:1542 is not listed on IDEAS
- Alfredo Di Tillio & Nenad Kos & Matthias Messner, 2014.
"The Design of Ambiguous Mechanisms,"
CESifo Working Paper Series
4949, CESifo Group Munich.
- Zhiguo He & Neng Wang & Mike Fishman & Peter DeMarzo, 2008.
"Dynamic agency and the q theory of investment,"
2008 Meeting Papers
1070, Society for Economic Dynamics.
- Spear, Stephen E. & Wang, Cheng, 2005.
"When to fire a CEO: optimal termination in dynamic contracts,"
Journal of Economic Theory,
Elsevier, vol. 120(2), pages 239-256, February.
- Stephen Spear & Cheng Wang, . "When to Fire a CEO: Optimal Termination in Dynamic Contracts," GSIA Working Papers 2002-E5, Carnegie Mellon University, Tepper School of Business.
- Spear, Stephen E. & Wang, Cheng, 2005. "When to Fire a CEO: Optimal Termination in Dynamic Contracts," Staff General Research Papers 11443, Iowa State University, Department of Economics.
- Biais, Bruno & Mariotti, Thomas & Rochet, Jean-Charles & Villeneuve, Stéphane, 2007.
"Large Risks, Limited Liability and Dynamic Moral Hazard,"
IDEI Working Papers
472, Institut d'Économie Industrielle (IDEI), Toulouse, revised Sep 2009.
- Bruno Biais & Thomas Mariotti & Jean-Charles Rochet & StÈphane Villeneuve, 2010. "Large Risks, Limited Liability, and Dynamic Moral Hazard," Econometrica, Econometric Society, vol. 78(1), pages 73-118, 01.
- Bruno Biais & Thomas Mariotti & Jean-Charles Rochet & Stéphane Villeneuve, 2010. "Large risks, limited liability, and dynamic moral hazard," Post-Print halshs-00491470, HAL.
- Brian J. Hall & Kevin J. Murphy, 2003. "The Trouble with Stock Options," Journal of Economic Perspectives, American Economic Association, vol. 17(3), pages 49-70, Summer.
- PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous-Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
When requesting a correction, please mention this item's handle: RePEc:nwu:cmsems:1543. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Fran Walker)
If references are entirely missing, you can add them using this form.