Opaque Contracts

TL;DR

This paper analyzes when contracts become opaque in markets where firms use data to target and describe contracts, exploring the effects of transparency regulations through a moral hazard model with risk-averse agents.

Contribution

It provides a geometric characterization of optimal contracts and identifies conditions for transparency versus opacity in contractual arrangements.

Findings

Optimal contracts can be characterized geometrically.

Conditions for when contracts are transparent or opaque are identified.

Application to ride-hailing driver payment schemes demonstrates practical relevance.

Abstract

Firms have access to abundant data on market participants. They use these data to target contracts to agents with specific characteristics, and describe these contracts in opaque terms. In response to such practices, recent proposed regulations aim to increase transparency, especially in digital markets. In order to understand when opacity arises in contracting and the potential effects of proposed regulations, we study a moral hazard model in which a risk-neutral principal faces a continuum of weakly risk-averse agents. The agents differ in an observable characteristic that affects the payoff of the principal. In a described contract, the principal sorts the agents into groups, and to each group communicates a distribution of output-contingent payments. Within each group, the realized distribution of payments must be consistent with the communicated contract. A described contract is transparent if the principal communicates the realized contract to the agent ex-ante, and otherwise it is opaque. We provide a geometric characterization of the principal's optimal described contract as well as conditions under which the optimal described mechanism is transparent and opaque. We apply our results to the design and description of driver payment schemes on ride-hailing platforms.