A General Framework for Robust Contracting Models

Abstract

We study a class of models of moral hazard in which a principal contracts with a counterparty, which may have its own internal organizational structure. The principal has non‐Bayesian uncertainty as to what actions might be taken in response to the contract, and wishes to maximize her worst‐case payoff. We identify conditions on the counterparty's possible responses to any given contract that imply that a linear contract solves this maxmin problem. In conjunction with a Richness property motivated by much previous literature, we identify a Responsiveness property that is sufficient—and, in an appropriate sense, also necessary—to ensure that linear contracts are optimal. We illustrate by contrasting several possible models of contracting in hierarchies. The analysis demonstrates how one can distill key features of contracting models that allow their findings to be carried beyond the bilateral setting.