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A Principal-Agent Model of Sequential Testing

  • Dino Gerardi
  • Lucas Maestri

This paper analyzes the optimal provision of incentives in a sequential testing context. In every period the agent can acquire costly information that is relevant to the principal's decision. Neither the agent's effort nor the realizations of his signals are observable. First, we assume that the principal and the agent are symmetrically informed at the time of contracting. We construct the optimal mechanism and show that the agent is indifferent in every period between performing the test and sending an uninformative message which continues the relationship. Furthermore, in the first period the agent is indifferent between carrying out his task and sending an uninformative message which ends the relationship immediately. We then characterize the optimal mechanisms when the agent has superior information at the outset of the relationship. The principal prefers to offer different contracts if and only if the agent types are sufficiently diverse. Finally, all agent types benefit from their initial private information.

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File URL: http://www.carloalberto.org/assets/working-papers/no.115.pdf
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Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 115.

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Length: 47 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:cca:wpaper:115
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  1. Cremer, J. & Khalil, F. & Rochet, J-C., 1997. "Contracts and Productive Information Gathering," Papers 97.468, Toulouse - GREMAQ.
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  9. Gromb, Denis & Martimort, David, 2004. "The Organization of Delegated Expertise," CEPR Discussion Papers 4572, C.E.P.R. Discussion Papers.
  10. PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous-Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
  11. Bengt Holmstrom & Paul R. Milgrom, 1985. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Cowles Foundation Discussion Papers 742, Cowles Foundation for Research in Economics, Yale University.
  12. Peter M. DeMarzo & Michael J. Fishman, 2007. "Optimal Long-Term Financial Contracting," Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 2079-2128, November.
  13. Laffont, Jean-Jacques & Tirole, Jean, 1986. "Using Cost Observation to Regulate Firms," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 614-41, June.
  14. Andrew Atkeson, 2010. "International lending with moral hazard and risk of repudiation," Levine's Working Paper Archive 200, David K. Levine.
  15. Gromb, Denis & Martimort, David, 2007. "Collusion and the organization of delegated expertise," Journal of Economic Theory, Elsevier, vol. 137(1), pages 271-299, November.
  16. Bergemann, Dirk & Hege, Ulrich, 1998. "Venture capital financing, moral hazard, and learning," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 703-735, August.
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