Locally robust contracts for moral hazard

We consider a moral hazard problem in which the principal has a slight uncertainty about how the agent's actions translate into output An incentive contract can be made robust against an epsilon amount of uncertainty, at the cost of a loss to the principal on the order of root epsilon, by refunding a small fraction of profit to the agent. We show that as epsilon goes to zero, this construction is essentially optimal, in the sense of minimizing the worst-case loss, among all modifications to the contract that do not depend on the details of the environment. (C) 2015 Elsevier B.V. All rights reserved.