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Contracting in Vague Environments

  • Marie-Louise Vierø

    ()

    (Department of Economics, Queen's University)

This paper shows that a new trade-off arises in the optimal contract when contracting takes place with vague information (objective ambiguity), reflecting that real-world contracting often takes place under imprecise information. The choice-theoretic framework captures a decision-maker`s attitude towards vagueness by his optimism. The new trade-off is between (a) incentive provision and (b) exploitation of heterogeneity that arises endogenously because of the vague environment. Consequently, the optimal contract may distort effort in order to relax incentive compatibility and fully exploit the endogenously created heterogeneity, even when the agent is risk neutral and there is no insurance need in the relationship.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1106.pdf
File Function: First version 2006
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Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1106.

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Length: 38 pages
Date of creation: Dec 2006
Date of revision:
Publication status: Published in American Economic Journal: Microeconomics
Handle: RePEc:qed:wpaper:1106
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  9. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
  10. Sujoy Mukerji & Jean-Marc Tallon, 2002. "Ambiguity Aversion and the Absence of Wage Indexation," Economics Series Working Papers 111, University of Oxford, Department of Economics.
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  13. Milne, Frank & Shefrin, H. M., 1987. "Information and securities: A note on pareto dominance and the second best," Journal of Economic Theory, Elsevier, vol. 43(2), pages 314-328, December.
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  17. Guillaume Carlier & Ludovic Renou, 2005. "Debt Contracts with ex-ante and ex-post Asymmetric Information: An Example," School of Economics Working Papers 2005-03, University of Adelaide, School of Economics.
  18. Hart, Oliver D., 1975. "On the optimality of equilibrium when the market structure is incomplete," Journal of Economic Theory, Elsevier, vol. 11(3), pages 418-443, December.
  19. Marie-Louise Vierø, 2006. "Exactly What Happens After the Anscombe-Aumann Race? Representing Preferences in Vague Environments," Working Papers 1094, Queen's University, Department of Economics.
  20. Andersen, Steffen & Fountain, John & Harrison, Glenn W. & Rutström, Elisabet E., 2009. "Estmating Aversion to Uncertainty," Working Papers 07-2009, Copenhagen Business School, Department of Economics.
  21. Bentley W. MacLeod, 2003. "Optimal Contracting with Subjective Evaluation," American Economic Review, American Economic Association, vol. 93(1), pages 216-240, March.
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  23. Tobias Adrian & Mark M. Westerfield, 2009. "Disagreement and Learning in a Dynamic Contracting Model," Review of Financial Studies, Society for Financial Studies, vol. 22(10), pages 3873-3906, October.
  24. Van den Steen, Eric, 2005. "Too Motivated?," Working papers 18180, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  25. B. Douglas Bernheim & Michael D. Whinston, 1997. "Incomplete Contracts and Strategic Ambiguity," Harvard Institute of Economic Research Working Papers 1787, Harvard - Institute of Economic Research.
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  27. David S. Ahn, 2008. "Ambiguity Without a State Space," Review of Economic Studies, Oxford University Press, vol. 75(1), pages 3-28.
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