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Dynamics of Contract Design with Screening

Author

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  • Jakša Cvitanić

    (EDHEC Business School, 06202 Nice, France)

  • Xuhu Wan

    (Department of Information and Systems Management, School of Business and Management, Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong)

  • Huali Yang

    (Department of Information and Systems Management, School of Business and Management, Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong)

Abstract

We analyze a novel principal--agent problem of moral hazard and adverse selection in continuous time. The constant private shock revealed at time 0 when the agent selects the contract has a long-term impact on the optimal contract. The latter is based not only on the continuation value of the agent who truthfully reports but is also contingent upon the continuation value of the agent who misreports, called the temptation value. The good agent is retired when the temptation value of the bad agent becomes large, because then it is expensive to motivate the good agent. The bad agent is retired when the temptation value of the good agent becomes small, because then the future payment does not provide sufficient incentives. We also compare the efficiency of the shutdown contract and the screening contract and find that the screening contract can bring more profit to the principal only when the agent's reservation utility is sufficiently small. This paper was accepted by Wei Xiong, finance.

Suggested Citation

  • Jakša Cvitanić & Xuhu Wan & Huali Yang, 2013. "Dynamics of Contract Design with Screening," Management Science, INFORMS, vol. 59(5), pages 1229-1244, May.
    • Handle: RePEc:inm:ormnsc:v:59:y:2013:i:5:p:1229-1244
    DOI: 10.1287/mnsc.1120.1600
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    References listed on IDEAS

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    Cited by:

    1. Thibaut Mastrolia & Dylan Possamaï, 2018. "Moral Hazard Under Ambiguity," Journal of Optimization Theory and Applications, Springer, vol. 179(2), pages 452-500, November.
    2. Moussawi-Haidar, Lama & Çömez-Dolgan, Nagihan, 2017. "Percentage rent contracts between co-stores," European Journal of Operational Research, Elsevier, vol. 258(3), pages 912-925.
    3. Thibaut Mastrolia & Dylan Possamai, 2015. "Moral hazard under ambiguity," Papers 1511.03616, arXiv.org, revised Oct 2016.
    4. Nicol'as Hern'andez Santib'a~nez & Dylan Possamai & Chao Zhou, 2017. "Bank monitoring incentives under moral hazard and adverse selection," Papers 1701.05864, arXiv.org, revised Jan 2019.
    5. Nicolás Hernández Santibáñez & Dylan Possamaï & Chao Zhou, 2020. "Bank monitoring incentives under moral hazard and adverse selection," Post-Print hal-01435460, HAL.
    6. Zhiguo He & Bin Wei & Jianfeng Yu & Feng Gao, 2017. "Optimal Long-Term Contracting with Learning," The Review of Financial Studies, Society for Financial Studies, vol. 30(6), pages 2006-2065.
    7. Jakv{s}a Cvitani'c & Dylan Possamai & Nizar Touzi, 2014. "Moral Hazard in Dynamic Risk Management," Papers 1406.5852, arXiv.org, revised Mar 2015.
    8. Jiajia Chang & Zhijun Hu & Hui Yang, 2020. "Venture Capital Contracting with Ambiguity Sharing and Effort Complementarity Effect," Mathematics, MDPI, vol. 8(1), pages 1-16, January.
    9. Dainelli, Francesco & Bet, Gianmarco & Fabrizi, Eugenio, 2024. "The financial health of a company and the risk of its default: Back to the future," International Review of Financial Analysis, Elsevier, vol. 95(PB).
    10. Zhou, Jianheng & Zhao, Ruijuan & Wang, Weishen, 2019. "Pricing decision of a manufacturer in a dual-channel supply chain with asymmetric information," European Journal of Operational Research, Elsevier, vol. 278(3), pages 809-820.
    11. Benedetti, Giuseppe, 2013. "Investissement optimal et évaluation d'actifs sous certaines imperfections de marché," Economics Thesis from University Paris Dauphine, Paris Dauphine University, number 123456789/12887 edited by Campi, Luciano.
    12. Nicolás Hernández Santibáñez & Dylan Possamaï & Chao Zhou, 2020. "Bank Monitoring Incentives Under Moral Hazard and Adverse Selection," Journal of Optimization Theory and Applications, Springer, vol. 184(3), pages 988-1035, March.
    13. Sarah Bensalem & Nicolás Hernández Santibáñez & Nabil Kazi-Tani, 2019. "Prevention efforts, insurance demand and price incentives under coherent risk measures," Working Papers hal-01983433, HAL.
    14. Nicolás Hernández Santibáñez & Dylan Possamaï & Chao Zhou, 2017. "Bank monitoring incentives under moral hazard and adverse selection," Working Papers hal-01435460, HAL.
    15. Wang, Huan & Lai, Chong & Lai, Shaoyong, 2021. "A study on the incentive compensation structure with payroll tax: A continuous-time principal-agent model," The North American Journal of Economics and Finance, Elsevier, vol. 58(C).
    16. Cl'emence Alasseur & Ivar Ekeland & Romuald Elie & Nicol'as Hern'andez Santib'a~nez & Dylan Possamai, 2017. "An adverse selection approach to power pricing," Papers 1706.01934, arXiv.org, revised Sep 2019.

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