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A note on optimal contracting with public ex post information under limited liability

Author

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  • Daniel Danau

    (Université de Caen Normandie)

  • Annalisa Vinella

    (Università degli Studi di Bari “Aldo Moro”)

Abstract

Riordan and Sappington (J Econ Theory 45:189–199, 1988) show that in an agency relationship in which the agent’s type is correlated with a public ex post signal, the principal may attain first best (full surplus extraction and efficient output levels) if the agent is faced with a lottery such that each type is rewarded for one signal realization and punished equally for all the others. Gary-Bobo and Spiegel (RAND J Econ 37:431–448, 2006) show that there exist locally incentive compatible lotteries such that limited liability constraints are satisfied, only if these constraints are satisfied when that kind of lottery is used. We explore how lotteries should be designed to attain not only local but also global incentive compatibility when the agent is protected by limited liability. The main issue with global incentive compatibility rests with intermediate types being potentially attractive reports to both lower and higher types. A lottery including three levels of profit (rather than only two) is found to be optimal under limited liability, in that it is most likely to be globally incentive compatible, if local incentive constraints are strictly satisfied. Conditions for first-best implementation are identified.

Suggested Citation

  • Daniel Danau & Annalisa Vinella, 2020. "A note on optimal contracting with public ex post information under limited liability," International Journal of Game Theory, Springer;Game Theory Society, vol. 49(1), pages 47-74, March.
    • Handle: RePEc:spr:jogath:v:49:y:2020:i:1:d:10.1007_s00182-019-00674-4
    DOI: 10.1007/s00182-019-00674-4
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    1. Chillemi, Ottorino & Galavotti, Stefano & Gui, Benedetto, 2020. "Optimal contracts with contingent allocation," Economics Letters, Elsevier, vol. 192(C).

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    More about this item

    Keywords

    Informative signals; Limited liability; Incentive compatibility;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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