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Contracting with private knowledge of signal quality

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  • Leon Yang Chu
  • David E. M. Sappington

Abstract

We characterize the optimal procurement contract in a setting where a supplier has privileged knowledge of the quality of a public signal about his production costs. The optimal contract exhibits important differences with standard contracts in adverse selection settings. For instance, the contract induces output both above and below first‐best levels. Furthermore, the induced output may not vary with the realized public signal unless the signal quality is sufficiently pronounced. In addition, output may increase as expected costs increase.

Suggested Citation

  • Leon Yang Chu & David E. M. Sappington, 2010. "Contracting with private knowledge of signal quality," RAND Journal of Economics, RAND Corporation, vol. 41(2), pages 244-269, June.
    • Handle: RePEc:bla:randje:v:41:y:2010:i:2:p:244-269
    DOI: 10.1111/j.1756-2171.2010.00098.x
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    Cited by:

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    2. Juan Camilo Serpa & Harish Krishnan, 2017. "The Strategic Role of Business Insurance," Management Science, INFORMS, vol. 63(2), pages 384-404, February.
    3. Deng, Zhongqi & Song, Shunfeng & Chen, Yongjun, 2016. "Private participation in infrastructure project and its impact on the project cost," China Economic Review, Elsevier, vol. 39(C), pages 63-76.
    4. Bolandifar, Ehsan & Chen, Zhong, 2020. "Hedging through index-based price contracts in commodity-based supply chains," Omega, Elsevier, vol. 90(C).
    5. Boleslavsky, Raphael & Lewis, Tracy R., 2016. "Evolving influence: Mitigating extreme conflicts of interest in advisory relationships," Games and Economic Behavior, Elsevier, vol. 98(C), pages 110-134.

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