Optimal team contracts

In this paper we evaluate certain challenges put forth by Eswaran and Kotwal (1984) and Rasmusen (1987) concerning the legitimacy of Holmstrom's (1982) proposed solution for the problem of moral hazard in teams. We demonstrate that the argument put forth by Rasmusen hinges on some rather extreme conditions concerning the verifiability of individual actions relating to renegotiation attempts; relaxing these conditions renders efficient budget-balancing contracts infeasible, as argued by Holmstrom. Second,we demonstrate that the criticism put forth by Eswaran and Kotwal is invalid, at least if one insists that clandestine deals must satisfy the same incentive-compatibility conditions required of the principal-agent contract proposed by Holmstrom.