American Economic Journal:
Microeconomics
ISSN 1945-7669 (Print) | ISSN 1945-7685 (Online)
Contracting in Vague Environments
American Economic Journal: Microeconomics
(pp. 104–30)
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 decisionmaker's attitude towards vagueness by his optimism. The new trade-off is between incentive provision and 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. (JEL D81, D82, D83, D86, L14)Citation
Vierø, Marie-Louise. 2012. "Contracting in Vague Environments." American Economic Journal: Microeconomics 4 (2): 104–30. DOI: 10.1257/mic.4.2.104Additional Materials
JEL Classification
- D81 Criteria for Decision-Making under Risk and Uncertainty
- D82 Asymmetric and Private Information
- D83 Search; Learning; Information and Knowledge; Communication; Belief
- D86 Economics of Contract: Theory
- L14 Transactional Relationships; Contracts and Reputation; Networks