On the Performance of Linear Contracts

Abstract

We examine the ability of linear contracts to replicate the performance of optimal unrestricted contracts in the canonical moral hazard setting with a wealth constrained, risk averse agent. We find that in a broad class of environments, the principal can always secure with a linear contract at least 95% of the profit that she secures with an optimal unrestricted contract, provided the productivity of the agent's effort is not too meager.