Resource Agency Relationship with Privately Known Exploration and Extraction Costs

We analyze exploration and extraction under asymmetric information. The principal delegates the exploitation of a resource to an agent (a mining firm) who possesses private information about the cost of exploration and learns further extraction cost information once reserves have been established and constrain extraction. The principal can only commit to current period royalty contracts: one discovery-transfer menu; one extraction-royalty menu conditional on reserves discovered. Compared with the symmetric information first best, avoiding adverse selection in extraction requires the optimum mechanism to increase discoveries by the lowest cost type and possibly others. This is tempered by a countervailing effect stemming from information asymmetry in exploration which tends to reduce discoveries, especially by higher cost types. We further detail implications on the forms taken by the inefficiencies associated with asymmetric information: abandoned reserves, excessive use of low-cost exploration prospects, and inefficient levels of technological sophistication in exploration and extraction sectors.