Contracting on Ambiguous Prospects

Authors


  • We thank Guillermo Calvo, Marc Henry, Ian Jewitt, Jean-Gabriel Lauzier, Rich McLean, Sujoy Mukerji, Onur Ozgur, Marcus Pivato and, especially, Deniz Dizdar and Sean Horan for conversations and useful suggestions. We are very grateful to the editor (Martin Cripps) and two anonymous referees, whose comments substantially improved the article. Finally, we also thank the audiences at the Center for Capitalism and Society at Columbia University, the 2012 Petralia Workshop, the 2013 SAET Conference and the 2014 IEA Conference. Mathieu Cloutier provided fine research assistance. Mario Ghossoub acknowledges financial support from the Social Sciences and Humanities Research Council of Canada.

Abstract

We study contracting problems where one party perceives ambiguity about the relevant contingencies. We show that the party who perceives ambiguity has to observe only the revenue/loss generated by the prospect object of negotiation, but not the underlying state. We, then, introduce a novel condition (vigilance), which extends the popular monotone likelihood ratio property to settings featuring ambiguity. Under vigilance, optimal contracts are monotonic and, thus, produce the right incentives in the presence of both concealed information and hidden actions. Our result holds irrespectively of the party's attitude towards ambiguity. Sharper results obtain in the case of global ambiguity-loving behaviour.

Ancillary