Robust Incentive Contracts

Journal of Institutional and Theoretical Economics, 2005

Posted: 30 May 2004

See all articles by Birger Wernerfelt

Birger Wernerfelt

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

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Abstract

Considering a principal-agent model in which the difficulty of the agent's action 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 have too strong incentives, but attempts to negotiate a stronger ex interim contract may result in bargaining failure. The relative efficiency of the two contracting regimes therefore depends on parameter values. 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, Adjustments, Low-powered Incentives

JEL Classification: D2, L2

Suggested Citation

Wernerfelt, Birger, Robust Incentive Contracts. Journal of Institutional and Theoretical Economics, 2005. Available at SSRN: https://ssrn.com/abstract=552023

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