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A Principal-Agent Model of Sequential Testing

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Abstract

This paper analyzes the optimal provision of incentives in a sequential testing context. In every period the agent can acquire costly information that is relevant to the principal's decision. Neither the agent's effort nor the realizations of his signals are observable. First, we assume that the principal and the agent are symmetrically informed at the time of contracting. We construct the optimal mechanism and show that the agent is indifferent in every period between performing the test and sending an uninformative message which continues the relationship. Furthermore, in the first period the agent is indifferent between carrying out his task and sending an uninformative message which ends the relationship immediately. We then characterize the optimal mechanisms when the agent has superior information at the outset of the relationship. The principal prefers to offer different contracts if and only if the agent types are sufficiently diverse. Finally, all agent types benefit from their initial private information.

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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1680.

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Length: 47 pages
Date of creation: Oct 2008
Date of revision:
Handle: RePEc:cwl:cwldpp:1680

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Keywords: Dynamic mechanism design; Information acquisition; Sequential testing;

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  1. Gromb, Denis & Martimort, David, 2004. "The Organization of Delegated Expertise," IDEI Working Papers 284, Institut d'Économie Industrielle (IDEI), Toulouse.
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  10. Peter M. DeMarzo & Michael J. Fishman, 2007. "Optimal Long-Term Financial Contracting," Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 2079-2128, November.
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  12. Bergemann, D. & Hege, U., 2001. "The Financing of Innovation: Learning and Stopping," Discussion Paper 2001-16, Tilburg University, Center for Economic Research.
  13. PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous-Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
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  15. Lewis, Tracy R & Sappington, David E M, 1997. "Information Management in Incentive Problems," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 796-821, August.
  16. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March.
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Cited by:
  1. Nicolas Klein & Tymofiy Mylovanov, 2011. "Should the Flatterers be Avoided?," 2011 Meeting Papers 1273, Society for Economic Dynamics.
  2. Johannes Horner & Larry Samuelson, 2009. "Incentives for Experimenting Agents," Cowles Foundation Discussion Papers 1726, Cowles Foundation for Research in Economics, Yale University.

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