Contracting with diversely naive agents

Kfir Eliaz*, Ran Spiegler

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

145 Scopus citations

Abstract

In standard contract-theoretic models, the underlying assumption is that agent types differ in their preference or cost parameters, and the principal's objective is to design contracts in order to screen this type. We study a contract-theoretic model in which the heterogeneity among agent types is of a "cognitive" nature. In our model, the agent has dynamically inconsistent preferences. Agent types differ only in their degree of "sophistication", that is, their ability to forecast the change in their future tastes. We fully characterize the menu of contracts which the principal offers in order to screen the agent's sophistication. The menu does not exclude any type: it provides a perfect commitment device for relatively sophisticated types, and "exploitative" contracts which involve speculation with relatively naive types. More naive types are more heavily exploited and generate a greater profit for the principal. Our results allow us to interpret real-life contractual arrangements in a variety of industries.

Original languageEnglish
Pages (from-to)689-714
Number of pages26
JournalReview of Economic Studies
Volume73
Issue number3
DOIs
StatePublished - Jul 2006

Funding

FundersFunder number
United States-Israel Binational Science Foundation2002298

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