The main contributions of the paper are summarized as follows: First, we propose
optimal contract design under symmetric and asymmetric information, respectively.
The principal then must design an
optimal contract that maximizes her objective (x - w), subject to two constraints: the agent chooses an action that maximizes U(w, e) and the expected utility of the contract must exceed his reservation utility (Lambert, 2001).
0]) be the firm's expected payoff yielded by the
optimal contract, given that the initial state of the economy is [[theta].
Hence, the board of directors' goal should be to find an
optimal contract (incentive plan in practice) which puts the interests of both the manager and the owners, in line (Fried, Law and Economics Workshop 2003).
This is the firm's profit if it draws its contract optimally, assuming both workers and managers respond to this
optimal contract according to their incentive constraints.
First, note that if e = 0 is the effort sought by the lender, then the
optimal contract is simply the first-best allocation described previously.
LR] is the
optimal contract for type LR at the premium rate c = [p.
The
optimal contract should provide the manager with the optimal incentive to provide productive effort.
The full information model and
optimal contract are given in Section 3.
These constraints are used to solve the team manager's maximization problem, thus the
optimal contract is characterized.
I consider the
optimal contract terms for both risk managers when the level of risk manager effort is observable and in the more interesting cases when the level of effort is unobservable.
Specifically, it is well known that when the agency problem is present (because the agent faces a binding limited-liability constraint or exhibits risk aversion), then the principal's
optimal contract provides rent to opportunistic agents.
