Contracts in informed-principal problems with moral hazard

Abstract

In many cases, an employer has private information about the potential productivity of a worker, who in turn has private information about the effort she exerts on the job. Much of the analysis of this environment in the literature restricts the employer to offer contracts that depend only on observable outcomes (e.g., profit). This paper studies the advantages to the employer of offering the worker a set of potential contracts from which the employer will choose after the worker has accepted the offer, so called menu-contracts. Specifically, in a two-state principal-agent problem with moral hazard, I show when the principal can obtain strictly higher expected payoffs than the restricted contracts of the literature by offering a menu-contract.

Signaling by an informed service provider

“…6 Assuming common knowledge of the outside option precludes one from analyzing the case of a problem solver, because it implies that the client with the higher value of service is also the one with a better service outcome. Second, when moral hazard is considered in the literature, such as in Beaudry (1994), Inderst (2001), Chade and Silvers (2002), Wagner (2013), Karle, Schumacher, and Staat (2016), and Bedard (2016), the moral hazard is on the side of the agent. In our discussion section, the moral hazard is on the side of the principal.…”

“…A more general mechanism is to allow the expert to offer a list of contracts to the client, while retaining the freedom to pick one out of the list if the list is accepted by the client (i.e., offering a “menu contract” in Maskin & Tirole, and Bedard, ). This more general mechanism does not change the set of equilibrium contracts for an enhancer.…”

“…It is natural that a service provider can have a costless way of sabotaging the client (free disposal), even though to improve the client's situation she has to incur a cost. Then, a contract with < 0 will always be rejected and thus not offered in equilibrium.12 A more general mechanism is to allow the expert to offer a list of contracts to the client, while retaining the freedom to pick one out of the list if the list is accepted by the client (i.e., offering a "menu contract" inTirole, 1992 andBedard, 2016). This more general mechanism does not change the set of equilibrium contracts for an enhancer.…”

On the equivalence of information design by uninformed and informed principals

“…Our paper is also is related to the literature on the informed principal in the standard mechanism design setting that was set in motion by the seminal paper of Myerson (1983). Some of this literature touches upon the question of information disclosure of the principal's private type to agents, particularly focusing on when full disclosure does not hurt the principal (e.g., Maskin and Tirole, 1990;Yilankaya, 1999;Skreta, 2011;Mylovanov and Tröger, 2014;Bedard, 2017;Mekonnen, 2021).…”