Moral Hazard with Soft Information
We study a model of moral hazard with soft information: the risk-averse agent takes an action and she alone observes the stochastic outcome; hence the principal faces a problem of ex post adverse selection. High-power contracts may not be appropriate when information is soft. The optimal truth-telling mechanism with audit requires a two-part tariff to be offered to the agent. The fixed component affords the agent a constant ex post information rent, which weakens the ex ante incentives for effort. We then establish an equivalence between a truthful mechanism and the general mechanism, for the agent’s payoff set and action choice. For the principal a truth-telling mechanism strictly dominates because it shields the agent from variations in the ex post payoffs. In that sense the optimal contract is unique.
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