Limited Commitment in Multi-Agent Contracting

Abstract

The analysis in this paper extends the single-agent/multi-task LEN model in Feltham/Xie (1994) to a multi-agent/multi-task context. A key feature of the paper is that we consider both full- and limited-commitment contracts. The former apply to settings in which the principal can specify the contracts for each agent and is assured that those contracts will be implemented. The latter apply to settings in which the agents can collude to effectively change the terms of their contracts. Equivalently, limited contracting occurs if the principal can set the terms of the aggregate compensation pool, but must let the agents choose how the pool is allocated among the agents. From the principal's perspective, full-commitment contracts dominate limited commitment contracts. There are two basic frictions that result in a reduced payoff with limited commitment. One is inefficient risk sharing which occurs because the agents will choose to share their incentive risk and this results in reduced induced effort. The other is inefficient allocation of effort, which occurs because when the agents allocate the aggregate incentives they ignore the principal's payoff and focus on inducing actions that maximize their compensation.

Keywords: multiple agents, limited commitment, incentive contracts

JEL Classification: D80, J33, M41, M43, M46