Informed Principal with Correlation.
Michela Cella, University of Milan
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ABSTRACT:
In this paper we analyze a simple two-sided adverse selection model with one principal and 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 of the agent. The main result of the paper is that the principal can extract a larger share of the surplus from the agent than in the case where her information is public. The principal can design such a contract because she exploits the fact that her type is an informative signal on the agent's one. We fully characterize the equilibrium of the principal agent game in which different types of principal offer the same menu of contracts that leave the agent uninformed about the principal's type. This gives more freedom to the principal when setting 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 agent have different beliefs about the probability distribution over the states of the world.
SUBJECT AREA:
D82, D20, L21
SUGGESTED CITATION:
Michela Cella,
"Informed Principal with Correlation."
(June 2007).
UNIMI - Research Papers in Economics, Business, and Statistics.
Economics.
Working Paper 20.
http://services.bepress.com/unimi/economics/art20
Paper presented by M. Galeotti.
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