Professor of Industrial Engineering
Tel Aviv University
Tel Aviv, Israel
In creating a new partnership (“syndicate”), what division of uncertain future profit should the parties select? We consider partnerships with no substantial initial investment and no moral hazard. Parties may differ in risk attitudes and beliefs. The common approach is bargaining. We take a different approach: One party proposes to the other a contract, similarly to the principal-agent approach. The initiating party wishes to maximize its expected utility, with respect to its own beliefs, subject to a n (“individual rationality” constraint on the other party’s expected utility, w.r.t its risk attitudes and beliefs. Using optimal control, we show that the optimal contract may be non-linear, and not even monotone increasing in the profit. We then show how to find the optimal monotone contract (still possibly non-linear). We then provide conditions for the optimality of linear contracts, common in practice, and conditions for one partner to receive a constant amount and the other the rest of the profit. We give examples of famous contracts from the history of jazz.
Yigal Gerchak is a Full Professor at the department of Industrial Engineering at Tel-Aviv University. His current research interests include coordination in decentralized supply chains, applications of game theory, operations management and decision analysis. He loves Turkish food (especially deserts!).
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