Seminar

Moral Hazard, Uncertain Technologies, and Linear Contracts

Martin Dumav (Universidad Carlos III de Madrid)

April 2, 2019, 11:00–12:30

Toulouse

Room MS 001

Economic Theory Seminar

Abstract

We analyze a moral hazard problem where both contracting parties have imprecise information (non-probabilistic uncertainty) about how actions translate to output. Agent has (weakly) more precise information than Principal, and both seek robust performance from a contract in relation to their respective worst-case scenarios. We show that linear contracts that align Principal's and Agent's pessimistic expectations are optimal. This result holds under very general conditions on the structure of information, including the case where Principal does not know exactly the extent of disagreement between her and Agent's information. Methodologically, by using only the properties of the sets of expected payos to derive the results, we provide a way to characterize optimal contracts without requiring such knowledge on the part of Principal. Substantively, our results provide some insights into the formal link between robustness and simplicity of contracts, in particular that non-linearity creates sub-optimal divergence between the respective worst-cases.