Ambiguity and Disclosure in The Principal-Agent Model

Abstract

A Principal-Agent model is examined in which the principal and the agent are ambiguity averse. With a risk neutral principal and a risk averse agent the presence of ambiguity aversion implies that the principal will not always fully insure the agent when effort is observable. Instead, risk may be introduced into the incentive scheme to take advantage of differences in ambiguity aversion. When effort is unobservable, depending on the relative ambiguity aversion of the principal and the agent, ambiguity aversion may increase or decrease the strength of the pay for performance relation relative to the standard model. A superiorly informed principal has an incentive to disclose information to the agent in order to alter the level of ambiguity perceived by the agent. Depending on the agent's risk aversion and on the relative levels of ambiguity aversion, the principal may have an interest in decreasing or increasing the ambiguity the agent perceives.