Insurance Reversal in an Agency Model with Uncertainty

The paper introduces Knigtian uncertainty, formalized by non-additive probabilities, within a simple agency model. Tie framework appears to be suitable to deal with issues like delegation iii innovative firms. The paper stresses that, with Knightian uncertainty, if the principal is pessimistic and the agent optimistic, the optimal contract may reverse the findings of the standard agency model with observability. Namely, the principal would fully insure himself across states of nature while the agent's reward will be state-dependent. Hence, even with observability, uncertainty could "require" the agent's compensation to operate as an incentive mechanism.