Incentives for Unaware Agents

Review of Economic Studies 79, 2012, 1151-1174

34 Pages Posted: 11 Nov 2011 Last revised: 24 Mar 2020

See all articles by Ernst-Ludwig von Thadden

Ernst-Ludwig von Thadden

Universitaet Mannheim; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Xiaojian Zhao

Monash University - Department of Economics

Date Written: September 1, 2011

Abstract

The paper introduces the problem of unawareness into Principal-Agent theory and discusses optimal incentive contracts when the agent may be unaware of her action space. Depending on the agent's default behavior, it can be optimal for the principal to propose an incomplete contract (that keeps the agent unaware) or a complete contract. The key tradeoff is that of enlarging the agent's choice set versus adding costly incentive constraints. If agents differ in their unawareness, optimal contracts show a self-reinforcing pattern: if there are few unaware agents in the economy optimal contracts promote awareness, if unawareness is wide-spread optimal contracts shroud the contracting environment, thus keeping the agent unaware.

Keywords: moral hazard, screening, incomplete contracts, unawareness

JEL Classification: D01, D86, D82, D83

Suggested Citation

von Thadden, Ernst-Ludwig and Zhao, Xiaojian, Incentives for Unaware Agents (September 1, 2011). Review of Economic Studies 79, 2012, 1151-1174, Available at SSRN: https://ssrn.com/abstract=1958069

Ernst-Ludwig Von Thadden (Contact Author)

Universitaet Mannheim ( email )

Department of Economics
Mannheim, 68131
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Xiaojian Zhao

Monash University - Department of Economics ( email )

Australia

HOME PAGE: http://https://sites.google.com/site/xjzhao81/

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