Credibly Confidential Contracts

Confidential contracts are signed to protect the identity of contracting parties from disclosure. However, such confidentiality is not credible if outsiders can perfectly infer the identity of the contracting parties in equilibrium. A confidential contract is credibly confidential when an inactive player uninvolved in the contract holds a non-degenerate Bayesian belief on the identity of the agent in the contractual relationship. The main research questions are whether and through what channel the preference for credible confidentiality influences incentive provision within a contract and how confidentiality concerns affect the endogenous formation of contractual relationships. With a preference for confidentiality, an agent’s participation is motivated by a confidentiality premium, which amplifies the conventional tradeoff between efficiency and risk premium. Confidentiality concerns thus distort incentives within a contractual relationship when the agent is risk-averse. Furthermore, the principal may deliberately contract with a less efficient agent with a higher equilibrium probability to reduce the confidentiality premium, leading to an inefficient match. Credible confidentiality provides an explanation for the distortion of incentive provision within a contractual relationship and an inefficient formation of contractual relationships even when the principal and the agents are rational and well-informed.