A Renegotiation-Proof Mechanism for a Principal-Agent Model

A principal-agent model with moral hazard and adverse selection is analyzed. In examining the principal-agent relationship, it is presumed that the principal and the agent are risk neutral. The agent can be of any type. The principal owns a production technology that requires as its input an effort...

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Bibliographic Details
Published in:The Rand journal of economics 1989-07, Vol.20 (2), p.256
Main Author: Demougin, Dominique M
Format: Article
Language:English
Subjects:
Economic models
Economic theory
Expected utility
Input output analysis
Studies
Online Access:Get full text
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Summary:A principal-agent model with moral hazard and adverse selection is analyzed. In examining the principal-agent relationship, it is presumed that the principal and the agent are risk neutral. The agent can be of any type. The principal owns a production technology that requires as its input an effort level taken by the agent. It is shown that, for a large class of environments, communication has no value for the principal; consequently, the principal cannot do better than to average over the different types of agents. Using this observation, a renegotiation-proof mechanism then is derived. Results have implications for a number of economic problems. One example that has received substantial attention is sharecropping. Although it is clear that efforts taken by a worker are potentially observable, a mechanism made to observe these efforts would be costly. Based on this observation and the results of the investigation, it is plausible that the simple crop-sharing rules observed are, in reality, optimal mechanisms.
ISSN:0741-6261
1756-2171