WPO, COV and IIA bargaining solutions

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Working paper
Peters Hans and Vermeulen Dries
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We consider optimal contracts when a principal has two sources to detect bad projects. The first one is an information technology without agency costs (ITP ), whereas the second one is the expertise of an agent subject to moral hazard, adverse selection and limited liability (ITA). First, we show that the principal does not necessarily benefit from access to additional information and thereby may prefer to ignore it. Second, we discuss different timings of information release, i.e. a disclosure contract offered to the agent after the principal announced the result of ITP , and a concealment contract where the agent exerts effort before ITP is checked. We find that concealment is superior whenever the quality of ITP is sufficiently low. Then, ITP is almost worthless under a disclosure contract, while it can still be exploited to reduce the agent’s information rent under concealment. If the quality of ITP improves, disclosure can be superior as it allows to adjust the agent’s effort to the up-dated expected quality of the project. However, even for a highly informative ITP , concealment can be superior as it mitigates the adverse selection problem. Finally, we prove that the principal always benefits from checking ITP if he chooses the optimal timing of information release. In particular, he may benefit only if he does not check ITP until the agent reported his findings.
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