Noisy observation in adverse selection models
The authors consider a principal-agent contracting problem under incomplete information where some of the agent's actions are imperfectly observable. Contracts take the form of reward schedules based on the noisy observation of the agent's action. They first review situations where the principal can reach the same utility as in the absence of noise. Then they focus on the use of linear reward schedules, which allow universal implementation, i.e. implementation of a given mechanism for any unbiased noise of observation, and on quadratic reward schedules, which only require the knowledge of the variance of the noise. They characterize conditions for a mechanism to be implementable under noisy observation. Copyright 1992 by The Review of Economic Studies Limited.
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