Contracting under Misspecification

Florian Mudekereza

Papers from arXiv.org

Abstract: This paper studies agency problems when both parties worry that the model linking action to output is misspecified. With observable actions, an optimal contract is linear in output, so performance pay arises solely to share misspecification exposure, the slope reflects the parties' relative robustness concerns, and its allocation is Pareto efficient. With hidden actions, this sharing rule survives and incentives add a nonlinear correction. Misspecification concerns can polarize effort by making intermediate actions impossible to implement. Moreover, ambiguity across competing models has asymmetric effects: uncertainty about desired actions raises the principal's payoff, whereas uncertainty about deviations can lower it.

Date: 2026-09
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