Imprecise Beliefs in a Principal Agent Model

Tilburg University, CentER Working Paper No. 1998-128

37 Pages Posted: 5 Aug 1999

See all articles by Luca Rigotti

Luca Rigotti

University of Pittsburgh - Department of Economics

Date Written: December 1998

Abstract

This paper presents a principal-agent model where the agent has multiple, or imprecise, beliefs. We model this situation formally by assuming the agent's preferences are incomplete. One can interpret this multiplicity as an agent's limited knowledge of the surrounding environment. In this setting, incentives need to be robust to the agent's different beliefs. We study whether robustness implies simplicity. Under mild conditions, we show the unique optimal contract has a two-wage structure; a flat payment and bonus. That is, all output levels are divided into two groups, and the optimal incentive scheme pays the same amount for all output levels in each group. We also show that a two-state two-action framework can be thought of as a reduced form of the original model. We solve explicitly the principal's problem in this case, and discuss some implications of our model for firm ownership.

JEL Classification: D23, D81, D82

Suggested Citation

Rigotti, Luca, Imprecise Beliefs in a Principal Agent Model (December 1998). Tilburg University, CentER Working Paper No. 1998-128. Available at SSRN: https://ssrn.com/abstract=166452 or http://dx.doi.org/10.2139/ssrn.166452

Luca Rigotti (Contact Author)

University of Pittsburgh - Department of Economics ( email )

4901 Wesley Posvar Hall
230 South Bouquet Street
Pittsburgh, PA 15260
United States

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