When are Robust Contracts Linear?

In today's seminar Gabriel discusses his paper on When are Robust Contracts Linear?

Abstract

We study a class of models of moral hazard in which a principal contracts with a counterparty, which may have its own internal organizational structure.

The principal has non-Bayesian uncertainty as to what actions might be taken in response to the contract, and wishes to maximize her worst-case payoff. We show that if the possible responses to any given contract satisfy two properties – a richness and a responsiveness property - then a linear contract is optimal.

This framework thus delineates a broad range of models in which linear contracts are optimally robust to uncertainty, including not only direct contracting with an agent, but also various models of hierarchical contracting and contracting with teams of agents.

We also further apply the modeling apparatus to compare the principal's payoffs across different organizational structures.