Is No. News Bad News? Information Transmission and the Role of "Early Warning" in the Principal-Agent Model
The standard principal-agent model neglects the potentially important role of information transmission from agent to principal. We study optimal incentive contracts when the agent has a private signal of the likelihood of the project's success. We show that the principal can costlessly extract this signal if and only if this does not lead her to intervene in the project in any way that will influence its outcome. Intervention undermines incentives by weakening the link between the agent's initial effort and the project's outcome. If possible, the principal commits not to cancel some projects with negative expected payoffs. To elicit early warning, contracts must reward agents for coming forward with bad news.
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Volume (Year): 28 (1997)
Issue (Month): 4 (Winter)
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