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Informed principal with correlation

  • Michela CELLA

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In this paper we analyze a simple two-sided adverse selection model with one principaland one agent. They are both risk neutral and have private information about their type. We also assume that the private information of the principal is correlated with the one ofthe agent. The main result of the paper is that the principal can extract a larger share ofthe surplus from the agent than in the case where her information is public. The principalcan design such a contract because she exploits the fact that her type is an informativesignal on the agent’s one. We fully characterize the equilibrium of the principal agent gamein which different types of principal offer the same menu of contracts that leave the agentuninformed about the principal’s type. This gives more freedom to the principal whensetting the transfers because the agent’s constraints need to hold only at an interim stage. The principal gains from a peculiarity of the correlated environment: different types of agenthave different beliefs about the probability distribution over the states of the world.

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Paper provided by Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano in its series Departmental Working Papers with number 2007-11.

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Date of creation: 31 Mar 2007
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Handle: RePEc:mil:wpdepa:2007-11
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  1. Maskin, Eric & Tirole, Jean, 1990. "The Principal-Agent Relationship with an Informed Principal: The Case of Private Values," Econometrica, Econometric Society, vol. 58(2), pages 379-409, March.
  2. Cremer, Jacques & McLean, Richard P, 1985. "Optimal Selling Strategies under Uncertainty for a Discriminating Monopolist When Demands Are Interdependent," Econometrica, Econometric Society, vol. 53(2), pages 345-61, March.
  3. 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.
  4. Roland Strausz, . "Deterministic versus Stochastic Mechanisms in Principal--Agent Models," Papers 020, Departmental Working Papers.
  5. Maskin, Eric & Tirole, Jean, 1992. "The Principal-Agent Relationship with an Informed Principal, II: Common Values," Econometrica, Econometric Society, vol. 60(1), pages 1-42, January.
  6. Myerson, Roger B, 1983. "Mechanism Design by an Informed Principal," Econometrica, Econometric Society, vol. 51(6), pages 1767-97, November.
  7. Hirshleifer, Jack, 1971. "The Private and Social Value of Information and the Reward to Inventive Activity," American Economic Review, American Economic Association, vol. 61(4), pages 561-74, September.
  8. McAfee, R Preston & Reny, Philip J, 1992. "Correlated Information and Mechanism Design," Econometrica, Econometric Society, vol. 60(2), pages 395-421, March.
  9. Cremer, Jacques & McLean, Richard P, 1988. "Full Extraction of the Surplus in Bayesian and Dominant Strategy Auctions," Econometrica, Econometric Society, vol. 56(6), pages 1247-57, November.
  10. Eric Maskin & Kevin W.S. Roberts, 2006. "On the Fundamental Theorems of General Equilibrium," Economics Working Papers 0074, Institute for Advanced Study, School of Social Science.
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