Tractability and Detail-Neutrality in Incentive Contracting

46 Pages Posted: 9 Mar 2009

See all articles by Alex Edmans

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Xavier Gabaix

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: February 2009

Abstract

This paper identifies a broad class of situations in which the contract is both attainable in closed form and detail-neutral. The contract's functional form is independent of the noise distribution and reservation utility; moreover, when the cost of effort is pecuniary, the contract is linear in output regardless of the agent's utility function. Our contract holds in both continuous time and a discrete-time, multi-period setting where action follows noise in each period. The tractable contracts of Holmstrom and Milgrom (1987) can thus be achieved in settings that do not require exponential utility, Gaussian noise or continuous time. Our results also suggest that incentive schemes need not depend on complex details of the particular setting, a number of which (e.g. agent's risk aversion) are difficult for the principal to observe.The proof techniques use the notion of relative dispersion and subdifferentials to avoid relying on the first-order approach, and may be of methodological interest.

Suggested Citation

Edmans, Alex and Gabaix, Xavier, Tractability and Detail-Neutrality in Incentive Contracting (February 2009). NYU Working Paper No. FIN-08-019. Available at SSRN: https://ssrn.com/abstract=1354507

Alex Edmans

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Xavier Gabaix (Contact Author)

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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