Contracting With Unknown Technologies

Abstract:

I study contracting with moral hazard when the agent has available a known (baseline) production technology but the principal thinks that the agent may also have access to other technologies, and maximizes his worst-case expected utilities under those possible technologies. All Pareto-efficient contracts take the form of participating preferred equity, a mixture of debt and equity. The nature of the contract depends on the most unproductive (in terms of stochastic dominance) technology that the principal thinks might be available to the agent. As this lower-bound technology becomes worse, the efficient contracts approach equity, generalizing existing work on robust contracting. When the lower-bound technology approaches the baseline technology, efficient contracts approach debt, providing more robust foundations for the classic financial contracting model.