Flexible contracts

Piero Gottardi, Jean-Marc Tallon and Paolo Ghirardato

No ECO2011/26, Economics Working Papers from European University Institute

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 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 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.

Keywords: Delegation; Flexibility; Agency Costs; Multiple Priors; Imprecision Aversion (search for similar items in EconPapers)
JEL-codes: D81 D82 D86 (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-cta and nep-mic
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http://cadmus.eui.eu/bitstream/handle/1814/18096/ECO_2011_26.pdf?sequence=1 main text

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