TY  - JOUR
AU  - Edmans,Alex
AU  - Gabaix,Xavier
TI  - Tractability in Incentive Contracting
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 15545
PY  - 2009
Y2  - November 2009
UR  - http://www.nber.org/papers/w15545
L1  - http://www.nber.org/papers/w15545.pdf
N1  - Author contact info:
Alex Edmans
The Wharton School
University of Pennsylvania
2318 Steinberg Hall - Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
Tel: 215/746-0498
Fax: 215/898-6200
E-Mail: aedmans@wharton.upenn.edu

Xavier Gabaix
New York University
Finance Department
Stern School of Business
44 West 4th Street, 9th floor
New York, NY 10012
Tel: 212-998-0257
Fax: 212-995-4233
E-Mail: xgabaix@stern.nyu.edu
AB  - This paper identifies a class of multiperiod agency problems in which the optimal contract is tractable (attainable in closed form). By modeling the noise before the action in each period, we force the contract to provide sufficient incentives state-by-state, rather than merely on average. This tightly constrains the set of admissible contracts and allows for a simple solution to the contracting problem. Our results continue to hold in continuous time, where noise and actions are simultaneous. We thus extend the tractable contracts of Holmstrom and Milgrom (1987) to settings that do not require exponential utility, a pecuniary cost of effort, Gaussian noise or continuous time. The contract's functional form is independent of the noise distribution. Moreover, if the cost of effort is pecuniary (multiplicative), the contract is linear (log-linear) in output and its slope is independent of the noise distribution, utility function and reservation utility. In a two-stage contracting game, the optimal target action depends on the costs and benefits of the environment, but is independent of the noise realization.
ER  -