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Information Asymmetry: Hidden Information

In: Contract Theory: Discrete- and Continuous-Time Models

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  • Jaeyoung Sung

    (Ajou University)

Abstract

We study a hidden information model where the agent makes not only hidden action, but also hidden project selection decisions. We show that the optimal contract is affected by not only the well-known outcome risk, but also a hidden information risk as well. As a result, the compensation-risk premium consists of two parts: the usual outcome-risk-sharing premium and a hidden-parameter-risk-sharing premium. Moreover, we argue that managers of high (low) risk firms can appear to overreact (underreact) to hidden news about the quality of project opportunities because they optimally invest more (less) aggressively to good news and more (less) conservatively to bad news than they would do were the news and their project decisions to be public.

Suggested Citation

  • Jaeyoung Sung, 2023. "Information Asymmetry: Hidden Information," Springer Books, in: Contract Theory: Discrete- and Continuous-Time Models, chapter 0, pages 261-272, Springer.
    • Handle: RePEc:spr:sprchp:978-981-99-5487-2_15
    DOI: 10.1007/978-981-99-5487-2_15
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