Contracting In Vague Environments

Marie-Louise Vierø

No 1106, Working Paper from Economics Department, Queen's University

Abstract: This paper shows that a new trade-off arises in the optimal contract when contracting takes place with vague information (objective ambiguity), reflecting that real-world contracting often takes place under imprecise information. The choice-theoretic framework captures a decision-maker`s attitude towards vagueness by his optimism. The new trade-off is between (a) incentive provision and (b) exploitation of heterogeneity that arises endogenously because of the vague environment. Consequently, the optimal contract may distort effort 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: contracts; vagueness; optimism; pessimism; incentives; objective ambiguity (search for similar items in EconPapers)
JEL-codes: D20 D80 D82 D86 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2006-12
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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https://www.econ.queensu.ca/sites/econ.queensu.ca/files/qed_wp_1106.pdf First version 2006 (application/pdf)

Related works:
Journal Article: Contracting in Vague Environments (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:qed:wpaper:1106

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