Double-Sided Moral Hazard and the Nature of Share Contracts

Abstract

Contractual arrangements involving revenue/profit sharing are often based on fairly simple, often linear, rules. In addition, in many contexts these contracts are not finely adjusted to the particular circumstances of individual agents or markets, nor do they vary over time to the extent current theories based on optimal contracting suggest they should. We develop a simple model of such revenue- or profit-sharing arrangements based on double-sided moral hazard and show that this model can account for many of these stylized facts. More specifically, the model shows that linear contracts can be optimal and that benefits from customizing terms can, in some cases, be quite limited, if not zero.