Finance Accounting Seminar: Contracting on Value

Abstract:

We revisit the optimal use of information under moral hazard while assuming that the agent can choose distributions nonparametrically. Under this assumption, optimal contracts behave as if the principal were making inferences about outcomes she values rather than about the agent’s action. This has significant implications for what measures are included in contracts and how those measures are used. Most importantly, Holmstr¨om’s (1979) informativeness principle changes. A performance measure is valuable if it improves inferences not about the agent’s action, but about outcomes the principal values; and if those outcomes are contractible, additional measures have no value.