Robust Incentive Contracts

17 Pages Posted: 26 Nov 2003

See all articles by Birger Wernerfelt

Birger Wernerfelt

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: June 27, 2003

Abstract

We look at a principal-agent model in which the agent has to perform an action, the difficulty of which is better known ex interim than ex ante. We compare two contracting regimes; one with commitment to an ex ante negotiated contract, and one with an ex interim negotiated contract. The ex ante contract can not be too steep, but attempts to negotiate a steeper ex interim contract may result in bargaining failure. We find that the relative efficiency of the two contracting regimes depends on the nature of the differences between tasks. In a dynamic version of the analysis, we further find that the comparison depends on the frequency with which new tasks are needed. The argument can be interpreted as an analysis of the tradeoff between weak incentives in the firm and the possibility of unsuccessful negotiations in the market.

Keywords: Theory of the Firm, Employment, Adjustments, Adaptation

JEL Classification: D2, L2

Suggested Citation

Wernerfelt, Birger, Robust Incentive Contracts (June 27, 2003). MIT Sloan Working Paper No. 4448-03. Available at SSRN: https://ssrn.com/abstract=470802 or http://dx.doi.org/10.2139/ssrn.470802

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