Dominant strategy mechanisms for contract auctions with risk aversion and moral hazard

Within the class dominant strategy incentive compatible mechanisms, the paper shows that there exists an optimal contracting mechanism for the principal for a version of the incomplete information principal-agent problem in which several agents compete for a contract and the principal selects an agent via a contract auction. In the present auction model, it assumes that the principal and the agents are risk averse, and the paper allows for uncountably many agent types. It also assumes that the principal’s probability measure over type profiles in such that correlation between agent’s types is possible. Thus, the paper does not require that agents’ types be independently distributed. Finally, it imposes limited liability constraints upon the set of contracts. Due to the nature of the individual rationality and incentive compatibility constraints, the existence problem is nonstandard and novel existence arguments are required. The paper proves existence using a measurable selection result and a new notion of compactness called K-compactness.