Robust Incentive Contracts

Considering a principal-agent model in which the difficulty of the agent's action is better known ex interim than ex ante, we compare two contracting regimes; one with commitment to an ex ante negotiated contract, and one with an ex interim negotiated contract. The ex ante contract cannot have too strong incentives, but attempts to negotiate a stronger ex interim contract may result in bargaining failure. The relative efficiency of the two contracting regimes therefore depends on parameter values. The argument can be interpreted as an analysis of the trade-off between weak incentives in the firm and the possibility of unsuccessful negotiations in the market.