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Contractual design in agency problems with non-monotonic cost and correlated information

Listed author(s):
  • Daniel Danau

    ()

    (Université de Caen Normandie)

  • Annalisa Vinella

    ()

    (Università degli Studi di Bari "Aldo Moro”)

We model an agency relationship in which the agent's cost is non-monotonic with respect to type and the type is correlated with a public ex-post signal. The principal can use lotteries to exploit the type-signal correlation within the limit of the agent's liability. We establish conditions for first-best implementation, highlighting two effects on contractual design. First, the structure of the optimal lottery varies across types and, for each type, it depends on whether the cost is U shaped or reverse U shaped with respect to type. Second, as compared to the case of monotonic cost, the design of incentive compatible lotteries is easier when the cost is U shaped, more difficult when the cost is reverse U shaped. The root of the second effect is that incentives are non-monotonic either below or above some interior types. The two effects involve that non-monotonicity is unfavorable to the principal when the cost is reverse U shaped. This conclusion is at odds with the wisdom, concerning settings without correlated information, that non-monotonicity, which triggers countervailing incentives, enhances contracting.

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File URL: http://www.seriesworkingpapers.it/RePEc/bai/series/SERIES_WP_02-2017.pdf
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Paper provided by Dipartimento di Economia e Finanza - Università degli Studi di Bari "Aldo Moro" in its series SERIES with number 02-2017.

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Length: 277
Date of creation: Mar 2017
Date of revision: Mar 2017
Handle: RePEc:bai:series:series_wp_02-2017
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  1. Dominique M. Demougin & Devon A. Garvie, 1991. "Contractual Design with Correlated Information under Limited Liability," RAND Journal of Economics, The RAND Corporation, vol. 22(4), pages 477-489, Winter.
  2. Ollier, Sandrine & Thomas, Lionel, 2013. "Ex post participation constraint in a principal–agent model with adverse selection and moral hazard," Journal of Economic Theory, Elsevier, vol. 148(6), pages 2383-2403.
  3. Iñaki Aguirre & Arantza Beitia, 2008. "Regulating a Multiproduct Monopolist with Unknown Demand: Cross-Subsidization and Countervailing Incentives," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 164(4), pages 652-675, December.
  4. Poudou, J.C. & Roland, M. & Thomas, L., 2007. "Universal Service Obligations and Competition with Asymmetric Information," Cahiers du LASER (LASER Working Papers) 2007.22, LASER (Laboratoire de Science Economique de Richter), Faculty of Economics, University of Montpellier 1.
  5. Degryse, Hans & de Jong, Abe, 2006. "Investment and internal finance: Asymmetric information or managerial discretion?," International Journal of Industrial Organization, Elsevier, vol. 24(1), pages 125-147, January.
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  7. Antonio Acconcia & Riccardo Martina & Salvatore Piccolo, 2008. "VERTICAL RESTRAINTS UNDER ASYMMETRIC INFORMATION: ON THE ROLE OF PARTICIPATION CONSTRAINTS -super-," Journal of Industrial Economics, Wiley Blackwell, vol. 56(2), pages 379-401, 06.
  8. Maggi G. & Rodriguez-Clare A., 1995. "On Countervailing Incentives," Journal of Economic Theory, Elsevier, vol. 66(1), pages 238-263, June.
  9. Alan Krause, 2009. "Education and Taxation Policies in the Presence of Countervailing Incentives," Economica, London School of Economics and Political Science, vol. 76(302), pages 387-399, 04.
  10. Jullien, Bruno, 2000. "Participation Constraints in Adverse Selection Models," Journal of Economic Theory, Elsevier, vol. 93(1), pages 1-47, July.
  11. Baron, David P & Myerson, Roger B, 1982. "Regulating a Monopolist with Unknown Costs," Econometrica, Econometric Society, vol. 50(4), pages 911-930, July.
  12. Cremer, Jacques & McLean, Richard P, 1988. "Full Extraction of the Surplus in Bayesian and Dominant Strategy Auctions," Econometrica, Econometric Society, vol. 56(6), pages 1247-1257, November.
  13. Daniel Danau & Analisa Vinella, 2016. "On the optimal use of correlated information in contractual design under limited liability," Economics Working Paper Archive (University of Rennes 1 & University of Caen) 2016-05, Center for Research in Economics and Management (CREM), University of Rennes 1, University of Caen and CNRS.
  14. Lewis, Tracy R. & Sappington, David E. M., 1989. "Countervailing incentives in agency problems," Journal of Economic Theory, Elsevier, vol. 49(2), pages 294-313, December.
  15. 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.
  16. repec:rje:randje:v:37:y:2006:2:p:431-448 is not listed on IDEAS
  17. Riordan, Michael H. & Sappington, David E. M., 1988. "Optimal contracts with public ex post information," Journal of Economic Theory, Elsevier, vol. 45(1), pages 189-199, June.
  18. Anke S. Kessler & Christoph Lülfesmann & Patrick W. Schmitz, 2005. "Endogenous Punishments In Agency With Verifiable Ex Post Information ," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(4), pages 1207-1231, November.
  19. Poudou Jean-Christophe & Roland Michel & Thomas Lionel, 2009. "Universal Service Obligations and Competition with Asymmetric Information," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 9(1), pages 1-25, October.
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