When partner knows best: asymmetric expertise in partnerships

This paper analyzes the problem of a principal (she) designing a contract for an agent (he) to form a short-lived partnership to exploit an asset before reselling, as in asset flipping. The agent possesses higher expertise than the principal in the sense that he can form a more-accurate assessment of the resale value of the asset before negotiating the dissolution of the partnership. By dissolving the partnership through a Texas shootout with the agent as proposer, the principal can “neutralize” her partner’s informational advantage and have him disclose the resale value for free. Thus, in the optimal contract, the agent’s superior expertise does not distort the structure of the partnership (i.e., the allocation of shares). The partners attain a higher aggregate surplus ex-ante if the principal commits to giving the asset away to the agent upon dissolving the partnership: She earns a lower revenue but lets all types of the agent enjoy a higher surplus. Thus, at the ex-ante stage, the agent could “bribe” the principal to implement this alternative. However, the additional surplus for lower types is insufficient to compensate the principal, so this higher ex-ante aggregate surplus is unattainable at the interim stage.