Purpose This paper aims to examine the design of optimal incentives for a firm’s tax department in the presence of information asymmetry. Design/methodology/approach This paper provides a theoretical model to examine the design of optimal incentives. The focus is on a situation in which a risk-averse tax department has private information about its efficiency type or effort to be exerted before the firm sets the incentive schemes. Findings This paper shows that a tax department’s risk aversion leads to a decline in the fraction of the cost borne by the tax department. It also shows that the optimal contract schemes should be designed to filter out as much uncontrollable risk as possible by using third-party information relevant to a tax department’s realized cost. Social implications It contributes to a better understanding of the impact of corporate incentive plans on firms’ tax practices. This study, by designing a theoretical model, helps explain why there exist differences in tax planning across firms based on the finding that incentives for tax planning activities differ across firms. Originality/value This paper is the first study that considers the situation in which tax managers’ risk-averse and types, as well as relevant information collected by the firms, can be used to set up incentive schemes and investigates whether and how the incentive schemes will be affected when firms improve their prior information by acquiring relevant information before the tax department acts.

Purpose The purpose of this paper is to explore the impact of information acquisition for the purpose of differentiating agencies operating in different localities on the design of optimal funding. Design/methodology/approach This paper is a theoretical study. The focus is on a situation in which agencies providing public services have perfect private information about their cost conditions before the government sets the formula for funding. Findings The authors show that, using a free signal correlated with costs of operation to differentiate agencies situated in different localities, the government can achieve better welfare for households across regions. However, when there exist non-negligible costs involved in the differentiating process, it may pay to acquire information only if the signal acquired is informative enough, i.e., the correlation between the signal and the agencies’ true cost conditions is strong enough. Social implications This paper is of interest to academics and policy makers. Acquiring information for tagging can be viewed as a preliminary screening process. Different types are then endowed with distinctly different incentives to control the costs of operating their agencies. Specifically, when the observed cost signal and the true cost conditions of agencies are positively correlated, the government should optimally be more aggressive in distorting the high-cost type’s effort decision by giving less incentive for the low-cost type agencies to cut costs than in the no-differentiation case, and vice versa. Originality/value This paper is the first study that explores the impact of information acquisition on the design of optimal funding for public service agencies.