Contracting Theory with Coincidence of Interest

Abstract

In the standard models of principal agent theory, the relationship between the principal and agent is adversarial in the sense that the objective of the agent is to maximize monetary income and minimize effort without regards for the objectives of the principal. In the real world, however, agents often have a personal stake in their contractual responsibilities. Furthermore, standard approaches to optimal contracting involve explicit monetary transfers, thereby excluding from analysis the case of non-profit agents. This paper presents a contracting model--the cooperative model--distinguished from standard models by the following three properties: first, the principal contracts with a non-profit agent for the provision of some commodity; second, the interests of the principal and agent coincide to the extent that their utilities are both increasing in the quality of the commodity provided; third, the using a suitable reformulation of the standard moral hazard variable, the optimal contract for the case of quasi-linear preferences has an extremely simple form. After the cooperative model is formalized, cost-plus and fixed price contracting are defined and compared, the form of the optimal contract is determined for the case of quasi-linear preferences, the suboptimality of cost-plus and fixed price contracting is demonstrated, and the possibility of decentralizing the optimal contract through a menu of linear contracts is explored. Finally, a standard model--the adversarial model--is presented for the purposes of comparison, along with a general model in which subsumes both models as special cases. Starting with the adversarial model and altering it in each of the three ways outlined above, it is possible to trace the ramifications of the assumptions underlying the cooperative model.