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American Economic Journal: Microeconomics: Vol. 4 No. 2 (May 2012)

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Contracting in Vague Environments

Article Citation

Vierø, Marie-Louise. 2012. "Contracting in Vague Environments." American Economic Journal: Microeconomics, 4(2): 104-30.

DOI: 10.1257/mic.4.2.104

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)

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Authors

Vierø, Marie-Louise (Queen's U, Kingston)

JEL Classifications

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

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