Journal Article

Incentives for Unaware Agents

Ernst-Ludwig Von Thadden and Xiaojian Zhao

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 79, issue 3, pages 1151-1174
Published in print July 2012 | ISSN: 0034-6527
Published online January 2012 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1093/restud/rdr050
Incentives for Unaware Agents

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  • Information, Knowledge, and Uncertainy
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The paper introduces the problem of unawareness into principal–agent theory and discusses optimal incentive contracts when the agent may be unaware of her action space. Depending on the agent's default behaviour, it can be optimal for the principal to propose an incomplete contract (that keeps the agent unaware) or a complete contract. The key trade-off is that of enlarging the agent's choice set versus adding costly incentive constraints. If agents differ in their unawareness, optimal contracts show a self-reinforcing pattern: if there are few unaware agents in the economy optimal contracts promote awareness, if unawareness is wide spread optimal contracts shroud the contracting environment, thus keeping the agent unaware.

Keywords: Moral hazard; Screening; Incomplete contracts; Unawareness; D01; D86; D82; D83

Journal Article.  10316 words.  Illustrated.

Subjects: Information, Knowledge, and Uncertainy ; Microeconomics

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