We examine contractual design in a principal-agent model under two forms of limited liability: non-negative constraints on the transfer payments to and the profits of the agent. We show that when limited liability is a binding constraint the principal cannot implement the first-best solution and the agent earns rents from private information. Limited liability is a binding constraint in the non-negative transfers model only when a signal is insufficiently responsive to type (inelastic). Further, as the production rule and profits are continuous in the type elasticity of the signal density function, the level of inefficiency is less than that which obtains with no signal. If a signal is sufficiently responsive to type (elastic) in this environment, then the principal can implement the first-best allocation and the value of the agent's private information is zero.
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Paper provided by Queen's University, Department of Economics in its series Working Papers with number
815.
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)
Roland Strausz, 2005.
"Interim Information in Long Term Contracts,"
Discussion Papers
40, SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
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