Contractibility Design
95 Pages Posted: 29 Nov 2023 Last revised: 3 Feb 2025
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: Suggested Citation
(February 03, 2025). Available at SSRN: https://ssrn.com/abstract=4621318 or http://dx.doi.org/10.2139/ssrn.4621318