Implementation With Contingent Contracts

Abstract

We study dominant strategy incentive compatibility in a mechanism design setting with contingent contracts where the payoff of each agent is observed by the principal and can be contracted upon. Our main focus is on the class of linear contracts (one of the most commonly used contingent contracts) which consist of a transfer and a flat rate of profit sharing. We characterize outcomes implementable by linear contracts and provide a foundation for them by showing that, in finite type spaces, every social choice function that can be implemented using a more general nonlinear contingent contract can also be implemented using a linear contract. We then qualitatively describe the set of implementable outcomes. We show that a general class of social welfare criteria can be implemented. This class contains social choice functions (such as the Rawlsian) which cannot be implemented using (uncontingent) transfers. Under additional conditions, we show that only social choice functions in this class are implementable.