Continuous-time contracting with ambiguous information

Abstract

This study examines the contracting problem in continuous time with ambiguous information. A problem of this nature arises, for example, in an employment relationship where there is limited knowledge, or ambiguity, about the technology that governs the performance. To address this problem, we connect the models of contracting problem in continuous time with the models of decision making under ambiguity in continuous time. The connection uses the continuous-time techniques and preserves the tractability in analysis. By means of computed examples we show that the consideration of ambiguity results in compensation schemes that are less sensitive to performance relative to the classical case. This answers to a criticism leveled at the extant theories of contracts that predicted compensation schemes that are unrealistically too sensitive to performance. Our work provides one possible rationale for simpler contracts through ambiguity.