Flexible contracts

Piero Gottardi, Jean-Marc Tallon and Paolo Ghirardato

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Abstract: This paper studies the costs and benefits of delegating decisions to superiorly informed agents, that is of adopting flexible contracts, 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 in two different environments, one with risk and one with ambiguity. We first determine and characterize the properties of the optimal flexible contract. We then show that the higher the agent'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 have imprecise probabilistic beliefs, the agent's degree of imprecision aversion introduces another agency cost, which again reduces the relative profitability of flexible contracts. JEL Classification: D86, D82, D81.

Keywords: Multiple Priors; Delegation; Agency Costs; Imprecision Aversion; Flexibility (search for similar items in EconPapers)
Date: 2017-05
New Economics Papers: this item is included in nep-cta, nep-des, nep-hrm, nep-mic and nep-upt
Note: View the original document on HAL open archive server: https://hal.science/hal-01238046v1
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Published in Games and Economic Behavior, 2017, John Nash Memorial, 103, pp.145-167. ⟨10.1016/j.geb.2016.01.013⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-01238046

DOI: 10.1016/j.geb.2016.01.013

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