Risk aversion, ambiguity aversion and the incentive problem with interim participation constraints

This work focuses on the effect of the principal's aversion toward both risk and ambiguity on the design of incentive contracts with interim participation constraints. We investigate how the second-best outputs are affected by the strength of the principal's risk aversion and ambiguity aversion, respectively. Our result implies that the principal with more risk aversion is ready to delegate a bigger production quantity to the inefficient agent. We also show how the principal's aversion to ambiguity affects the production quantity allocated to the inefficient agent and clarify whether ambiguity aversion reinforces the effect of risk aversion.