Contractibility Design

95 Pages Posted: 29 Nov 2023 Last revised: 3 Feb 2025

See all articles by Roberto Corrao

Roberto Corrao

Massachusetts Institute of Technology (MIT), Department of Economics, Students

Joel P. Flynn

Yale University

Karthik Sastry

Princeton University - Department of Economics

Date Written: February 03, 2025

Abstract

We introduce a principal-agent model with costs of determining what is contractible. If there are front-end costs of distinguishing one action from another when writing contracts, then optimal contracts specify finitely many actions out of a continuum. This conclusion holds even when the cost of complete contracts is arbitrarily small but does not hold in the presence of arbitrarily large back-end costs of enforcing contracts. We apply our results to the design of employment contracts. Our model rationalizes the common practice of using discrete pay grades and predicts their rigidity in the face of small---but not large---productivity changes.

Keywords: Mechanism Design, Incomplete Contracts, Principal-Agent Models, Nonlinear Pricing, Costs of Contracts

JEL Classification: D82, D86

Suggested Citation

Corrao, Roberto and Flynn, Joel P. and Sastry, Karthik, Contractibility Design
(February 03, 2025). Available at SSRN: https://ssrn.com/abstract=4621318 or http://dx.doi.org/10.2139/ssrn.4621318

Roberto Corrao

Massachusetts Institute of Technology (MIT), Department of Economics, Students ( email )

Cambridge, MA
United States

Joel P. Flynn (Contact Author)

Yale University ( email )

493 College St
New Haven, CT CT 06520
United States

Karthik Sastry

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

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