Optimal Contracting with Subjective Evaluation: The Effects of Timing, Malfeasance and Guile

65 Pages Posted: 11 Apr 2016

See all articles by W. Bentley MacLeod

W. Bentley MacLeod

Columbia University - Department of Economics; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Teck Yong Tan

Nanyang Technological University (NTU) - Division of Economics

Date Written: April 2016

Abstract

We introduce a general Principal-Agent model with subjective evaluation and malfeasance characterized by two-sided asymmetric information on performance that allows for an arbitrary information structure. Two generic contract forms are studied. An authority contract has the Principal reveal his information before the Agent responds with her information. Under such a contract, the Agent's compensation varies only with the Principal's information, while her information is used to punish untruthful behavior by the Principal. Conversely, a sales contract has the Agent reveal her information first. In this case, the Agent's performance incentives are affected by the information revealed by both parties. Because the Agent's information affects her compensation, the information revelation constraints are more complex under a sales contract, and provide a way to integrate Williamson's (1975) notion of guile into agency theory. We find that designing sales contracts for expert agents, such as physicians and financial advisors, are significantly more complex than designing optimal authority contracts.

Suggested Citation

MacLeod, William Bentley and Tan, Teck Yong, Optimal Contracting with Subjective Evaluation: The Effects of Timing, Malfeasance and Guile (April 2016). NBER Working Paper No. w22156. Available at SSRN: https://ssrn.com/abstract=2762063

William Bentley MacLeod (Contact Author)

Columbia University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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IZA Institute of Labor Economics ( email )

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Teck Yong Tan

Nanyang Technological University (NTU) - Division of Economics ( email )

HSS 04-53, 14 Nanyang Drive
Singapore, 639798
Singapore

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