Limited Commitment in Multi-Agent Contracting

Abstract

The analysis in this paper extends the single-agent/multi-task LEN model in Feltham and Xie (1994) to a multi-agent/multi-task context. A key feature of the paper is that we consider centralized contracting with both full and limited commitment. The former refers to settings in which the principal specifies the contracts for each agent and is assured that those contracts will be implemented. The latter refers to settings in which the principal cannot preclude inter-agent negotiation to change the terms of their initial contracts. The results from centralized contracting with limited commitment are also obtained from decentralized contracting, in which the principal sets the terms of an aggregate compensation pool and delegates the allocation of the pool to one of the agents.

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. One of the interesting results is that the impact of an agent's risk tolerance and the precision of a performance report on managerial incentives may be in the opposite direction for full and limited commitment.

Keywords: Incentives, Inter-agent negotiation, Multi-agent contracting, Performance evaluation

JEL Classification: M40, M41, M46, M52, D82, D86, C70