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Informed principal with correlation

Author

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  • Michela CELLA

Abstract

In this paper we analyze a simple two-sided adverse selection model with one principaland one agent. They are both risk neutral and have private information about their type. We also assume that the private information of the principal is correlated with the one ofthe agent. The main result of the paper is that the principal can extract a larger share ofthe surplus from the agent than in the case where her information is public. The principalcan design such a contract because she exploits the fact that her type is an informativesignal on the agent?s one. We fully characterize the equilibrium of the principal agent gamein which different types of principal offer the same menu of contracts that leave the agentuninformed about the principal?s type. This gives more freedom to the principal whensetting the transfers because the agent?s constraints need to hold only at an interim stage. The principal gains from a peculiarity of the correlated environment: different types of agenthave different beliefs about the probability distribution over the states of the world.

Suggested Citation

  • Michela CELLA, 2007. "Informed principal with correlation," Departmental Working Papers 2007-011, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano.
    • Handle: RePEc:mil:wpdepa:2007-011
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    More about this item

    Keywords

    Informed principal; private values; correlation;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D20 - Microeconomics - - Production and Organizations - - - General
    • L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm

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