Incentives for Contract Designers

Abstract

This paper examines the optimal provision of incentives for contract designers. A principal hires an agent to draft a contract that is incomplete because the ex-ante specified design might not be appropriate ex-post. The degree of contract incompleteness is endogenously determined by the effort exerted by the agent, who can manipulate the principal's beliefs because his effort may not be observable (moral hazard), and he might be better informed at the outset (adverse selection). We characterize the optimal incentive scheme for the agent and discuss implications for the degree of buyer-seller contract incompleteness and the optimal prices. Without adverse selection, the principal-seller contract is more incomplete and is coupled with a smaller price in a better environment. If the adverse selection problem is severe enough, the principal-seller contract is less incomplete and is coupled with a higher price in a better environment.