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Optimal Contract under Moral Hazard and Soft Information

Optimal Contract under Moral Hazard and Soft Information published on

Guillaume Roger has an interesting paper in the current American Economic Journal: Microeconomics looking at the case in which the agent must self-report the ex-post performance outcome. This is a worthwhile extension of the typical principal-agent model, since in many real world cases there is information asymmetry ex post between the agent (who has better information on actual outcomes) and the principal. The abstract follows:

I study a model of moral hazard with soft information: the agent alone observes the stochastic outcome of her action; hence the principal faces a problem of ex post adverse selection. With limited instruments the principal cannot solve these two problems independently; the ex post incentive for misreporting interacts with the ex ante incentives for effort. This affects the shape and properties of the optimal contract, which fails to elicit truthful revelation in all states. In this setup audit and transfer become strategic complements; this is rooted in the nonseparability of the problem.

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