Dynamic robust contract and incentive strategy under model uncertainty

This study extends the robust contract model proposed by Ling et al. (2021) by incorporating entrepreneur concerns about model uncertainty. We find that the robust contract becomes increasingly intricate because of the non-linear relationships between the entrepreneur's concern for model uncertainty and factors such as investors' value, dynamic investment, and dynamic incentive sensitivity. Moreover, we observe that the incentive level changes dynamically based on firm performance. It remains at its minimum value in the low-performance region, and as both the entrepreneurs' and investors' concerns about model uncertainty increase, investors tend to provide a higher incentive level in the mid-performance region, but a lower one in the high-performance region than that reported by Ling et al. (2021). Consequently, entrepreneurs can receive dividends earlier using these strategies. Our study indirectly highlights the strong correlation between entrepreneurs' attitudes towards model uncertainty and firm performance. Adding entrepreneurs' consideration of model uncertainty to the extended model is beneficial for mitigating excessive risk-taking behaviour and achieving optimal risk sharing.