Simple Contracts under Observable and Hidden Actions

Chen, Bo and Chen, Yu and Rietzke, David Michael (2019) Simple Contracts under Observable and Hidden Actions. Economic Theory. ISSN 0938-2259

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Abstract

We consider a general framework for multitask moral hazard problems with observable and hidden actions. Ideally, the principal in our framework can design optimal contracts that depend on both observable (and verifiable) actions and realized outcomes. Given a mild assumption on the existence of a punishment scheme, we identify a general equivalence result, dubbed the “forcing principle,” which states that every optimal contract in our framework is strategically equivalent to a simple forcing contract, which only specifies an outcome-contingent reward scheme and an action profile, and the agent receives the outcome-contingent reward only if he follows the recommended observable actions (and is otherwise punished severely). The forcing principle has useful implications: it confers analytical advantage for the existence and computation of optimal contracts in our setting. It also highlights and makes explicit the importance of the existence of the punishment scheme in characterizing first-best benchmarks in moral hazard problems.

Item Type: Journal Article
Journal or Publication Title: Economic Theory
Additional Information: The final publication is available at Springer via http://dx.doi.org/10.1007/s00199-019-01187-7
Uncontrolled Keywords: /dk/atira/pure/subjectarea/asjc/2000/2002
Subjects:
Departments: Lancaster University Management School > Economics
ID Code: 132326
Deposited By: ep_importer_pure
Deposited On: 29 Mar 2019 16:20
Refereed?: Yes
Published?: Published
Last Modified: 25 Feb 2020 04:20
URI: https://eprints.lancs.ac.uk/id/eprint/132326

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