Contracting in Vague Environments

Marie-Louise VierAy

No 273582, Queen's Economics Department Working Papers from Queen's University - Department of Economics

Abstract: This paper shows that a new trade-o arises in the optimal contract when contracting takes place with vague information (objective ambiguity), re ecting that real-world contracting often takes place under imprecise information. The choicetheoretic framework captures a decision-maker's attitude towards vagueness by his optimism. The new trade-o is between (a) incentive provision and (b) exploitation of heterogeneity that arises endogenously because of the vague environment. Consequently, the optimal contract may distort eort in order to relax incentive compatibility and fully exploit the endogenously created heterogeneity, even when the agent is risk neutral and there is no insurance need in the relationship.

Keywords: Financial; Economics (search for similar items in EconPapers)
Pages: 39
Date: 2006-12
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Persistent link: https://EconPapers.repec.org/RePEc:ags:quedwp:273582

DOI: 10.22004/ag.econ.273582

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