A General Model of Coexisting Hidden Action and Hidden Information
We consider a general agency model with coexisting hidden action and hidden information. We prove that, with minor technical qualifications, independence of the production technology from the consumer type is necessary and sufficient for welfare irrelevance of hidden action. Our result clarifies and confirms the main conclusion drawn in the existing literature on mixed models, that if the parties are risk neutral and the production technology is not correlated with private information, then hidden action is irrelevant. However it makes it clear that even under risk neutrality this conclusion does not extend to the correlated case, which in practice occurs quite frequently. We illustrate it with a realistic example where neither hidden action nor hidden information on their own lead to welfare losses, while their combination does.
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