Delegating Trial and Error

Abstract

A principal delegates a problem to an agent who solves it using trial and error. The principal cannot observe the agent's actions or the outcomes of the trials. Trials are independent, heterogeneous, and privately costly. The optimal contract with commitment balances the agent's compensation against the timeliness of a solution. In equilibrium, the agent earns rents and inefficiently idles. The optimal renegotiation-proof contract eliminates idleness, restores the first-best, but cedes significant additional rents to the agent. A principal that lacks commitment might optimally slow down problem solving by inhibiting the agent's ability to perform trial and error.

Keywords: Trial and error, agency problems, renegotiation

JEL Classification: D82, D86, O31