Contract Theory
Course content
The course provides an introduction to contract theory. Contract theory examines the characteristics of optimal contracts when one party has certain relevant knowledge that the other party does not have.
The course consists of two parts. In the first part, some of the basic ideas in contract theory are presented. We will, in particular, look at optimal contracts when one party has hidden information (adverse selection) or can take a hidden action (moral hazard). In the second part of the course we apply the insights obtained to a number of specific economic questions, studying some original journal articles.
In the first part we will study selected sections of chapters 25 of the textbook by Laffont and Martimort. Chapter 2 explains the basic idea and insights of adverse selection. Chapter 3 studies some important extensions of the basic adverse selection model: for example, environments where the agent may be of more than two “types”, which may lead to “bunching” (i.e., several types being offered the same contract).
Chapter 4 explains the basic idea and insights of moral hazard, using a very stylized model with two effort levels and two possible outcomes. Chapter 5 extends this model in some interesting ways, for example: environments with a continuous effort variable, leading to a discussion of the socalled firstorder approach.
The journal articles that we will study concern various topics, including managerial incentives and product market competition; regulation; and incentives for marketing agents to “missell”.
The primary aim of the course is to introduce students to
central results and insights in contract theory. An additional aim
is to familiarize students with some selected examples of how
contract theory can be used to study economic questions. A broader
aim is that students who take the course will, by working
extensively with theoretical models, acquire analytical skills that
are transferable to other kinds of intellectual problems.
After having successfully completed the course, the students will
be able to formulate and solve contract theory models. The students
will also be able to read professional journal articles that apply
contract theory and to use this broad analytical approach when
analyzing and thinking about questions where incentives play a
role.
In order to pass the course, the student must demonstrate familiarity with and understanding of the approach of contract theory. Moreover, the student must show ability to solve and work with models used in contract theory and ability to understand the logic behind the results. At the end of the course, the very good should be able to demonstrate full or almost full capability of using and understanding the techniques of analysis taught in the course.
To sum up, after having completed the course the students should:
Knowledge:
 Understand the main ideas and results in the contract theory literature.
 Be familiar with some important analytical techniques used in contract theory.
Skills:
 Be able to formulate and solve contract theory models.
 Be able to read professional journal articles that apply contract theory.
Competencies:
 Be able to use the broad analytical approach of contract theory when analyzing and thinking about questions and intellectual problems where incentives play a role.
Lectures
Note: Details of the syllabus may change.
Textbook (selected parts)
Laffont, JeanJacques, and David Martimort (2002), The Theory of Incentives: The PrincipalAgent Model, Princeton University Press.
Preliminary plan:

Sections 2.12.6, 2.9, and 2.10 (except 2.10.2 and 2.10.3).

Sections 3.1, 3.3.1 (including introduction to 3.3) and 3.7.

Introduction to Ch. 4 (pages 145148), Sections 4.14.4 up until and including Proposition 4.5 on page 161.

Sections 4.8.2 (on sharecropping) and 4.8.5 (on insurance contracts).

Section 4.5 (pages 163167) – however, the formal model with a riskaverse agent is excluded although the discussion on page 167 is included.

Section 5.1.2. Also the discussion related to the firstorder approach in Sections 5.1.1 and 5.1.3 (hence not the formal models).

Sections 5.2.1 and 5.2.2.
Preliminary list of journal articles/book chapters (typically only selected pages):

Prendergast, Canice. “The Provision of Incentives in Firms”. Journal of Economic Literature, 37(1), 1999.

Vickers, John. “Concepts of competition” Oxford Economic Papers, 47(1), 1995.

Inderst, Roman, and Marco Ottaviani. “Misselling through Agents” American Economic Review, 99(3), 2009.

Laffont, JeanJacques, and Jean Tirole, A Theory of Incentives in Procurement and Regulation, MIT Press, 1993 (parts of Chapter 1).
 Schmidt, Klaus M. “Managerial Incentives and Product Market Competition”. Review of Economic Studies, 64(2), 1997.
It is recommended that, prior taking the course Contract Theory, the student achieves a certain proficiency in solving gametheoretic models, at the level of Micro III at the Department of Economics. It is also possible to follow Micro III in parallel with the contract theory course. A large part of the course consists of analyzing formal microeconomic models. The students therefore should have a sound knowledge of basic microeconomics and the basic mathematical tools that microeconomists use (e.g., KuhnTucker and similar optimization techniques).
Schedule:
3 hours lectures every week from week 36 to 50 (except week 42).
The overall schema for the Master can be seen at
https://intranet.ku.dk/economics_ma/courses/CourseCatalogueE17/Courseschema/Pages/default.aspx
Timetable and venue:
To see the time and location of lectures please press the link
under "Se skema" (See schedule) at the right side of this
page. E means Autumn.
You can find the similar information partly in English at
https://skema.ku.dk/ku1718/uk/module.htm
Select Department: “2200Økonomisk Institut” (and wait for
respond)
Select Module:: “2200E17; [Name of course]””
Select Report Type: “List – Weekdays”
Select Period: “Efterår/Autumn – Weeks 315”
Press: “ View Timetable”
for enrolled students. More information about registration, schedule, rules, courses etc. can be found at the intranet for Master students (UK) and Master students (DK).
Registration and information for foreign students not enrolled please find more information at Study Economics.
For enkelfagsstuderende sker tilmelding via Åbent Universitet og Merit.
Læs om uddannelsen og studieordningen på KA uddannelsen i økonomi.
 ECTS
 7,5 ECTS
 Type of assessment

Written examination, 3 hours under invigilationIndividual exam at the computers of Copenhagen University.
The exam assignment is given in English and can be answered in English or in Danish. Language must be chosen at the course or exam registration.  Aid
 Without aids
 Marking scale
 7point grading scale
 Censorship form
 External censorship
if chosen by the Head of Studies.
Criteria for exam assessment
The student must in a satisfactory way demonstrate that he/she has mastered the learning outcome of the course.
The final exam tests the students' knowledge, skills, and competencies in corporate finance theory, as described in the course learning outcomes. Grading is on a pass/fail basis. In order to obtain a passing grade, students must demonstrate in a satisfactory way that they have met the learning outcomes related to all three relevant areas: intuition, formal mathematical modeling, and application to cases.
Single subject courses (day)
 Category
 Hours
 Lectures
 42
 Preparation
 161
 Exam
 3
 English
 206
Kursusinformation
 Language
 English
 Course number
 AØKA08055U
 ECTS
 7,5 ECTS
 Programme level
 Full Degree Master
 Duration

1 semester
 Price

Information about admission and tuition fee: Master and Exchange Programme, credit students and guest students (Open University)
 Schedulegroup

and venue:
Go to "Remarks"
Exam and resits: Go to "Exam"  Studyboard
 Department of Economics, Study Council
 Department of Economics
Course responsible
 Johan Lagerlöf (14767b746d7a3a786d73717e787b724c716f7b7a3a77813a7077)
Teacher
Lectures: See ‘Course responsibles’
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