Ambiguity, Agency Relationships and Adverse Selection

This paper applies to adverse selection theory the advances made in the field of ambiguity theory. It shows that i) a relevant second-best contract induces no production distortion considering the efficient agent as in the standard case. But the principal has to pay a higher information rent compared to the standard case; ii) This is due to the level of transfer paid to the inefficient agent which is higher than under the complete information system. The above results are reached when the agent has neither fully optimistic nor optimistic beliefs. When, he feels an extreme feeling then, the information rent and second best transfers are inside bounds similar to the SEU case; iv) as a consequence, the principal has to adopt a flexible behavior consisting in acquiring new information for becoming either entirely optimistic or pessimistic to minimize transfers and information rent in the proposed delegation contract.