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Flexible contracts

Author

Listed:
  • Piero Gottardi
  • Jean Marc Tallon
  • Paolo Ghirardato
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.

Suggested Citation

  • Piero Gottardi & Jean Marc Tallon & Paolo Ghirardato, 2011. "Flexible contracts," Economics Working Papers ECO2011/26, European University Institute.
    • Handle: RePEc:eui:euiwps:eco2011/26
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    References listed on IDEAS

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    More about this item

    Keywords

    Delegation; Flexibility; Agency Costs; Multiple Priors; Imprecision Aversion;
    All these keywords.

    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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