Costless Information and Costly Verification: A Case for Transparency

Abstract

A principal has to take a binary decision. She relies on information privately held by an agent who prefers the same action regardless of his type. The principal cannot incentivize with transfers but can learn the agent's type at a cost. Additionally, the principal privately observes a signal correlated with the agent's type. Transparent mechanisms are optimal: The principal's payoff is the same as if her signal was public. A simple cutoff form is optimal: Favorable signals ensure the agent's preferred action. Signals below this cutoff lead to the non-preferred action unless the agent appeals. An appeal always triggers type verification.

Mechanism Design with Costly Inspection

“…There is a literature on mechanism design with costly state verification and without transfers, e.g., Ben-Porath et al (2014), Erlanson and Kleiner (2019), Halac and Yared (2020), Knoepfle (2023), andAhmadzadeh (2024). Models with and without transfers differ in their predictions as well as in the techniques needed to analyze them.…”

The Irrelevance of Fee Structures for Certification

“…We abstract from any moral hazard problems of certification and refer for such considerations to Ozerturk (2014) andBizzotto and Vigier (2021).6 For papers that focus on the market transparency effect of certification seePollrich and Wagner (2016),Stahl and Strausz (2017),Harbaugh and Rasmusen (2018), andKattwinkel and Knoepfle (2022).7 Because in the canonical adverse selection setup, trade takes place at a price that equals the buyer's expected willingness to pay, buyer-rents are always zero.…”