Signaling by an Expert

Abstract

In this paper, we allow an expert with moral hazard to have private information on what would happen to his client both with his service and without his service. The contingent component in the contract this expert offers helps overcome his moral hazard, but also serves as a signal of his private information. We distinguish two concepts: the value of the service and the service outcome. Focusing on Intuitive-Criterion-satisfying equilibria, we show that the expert’s incentive to signal through the contract influences the contract very differently depending on whether a good service outcome is associated with a high service value or a low service value. In the former case, the contingent fee in any pooling equilibrium is positive and a high-value expert offers a more contingent contract than a low-value expert in any separating equilibrium. In the latter case, under some conditions there exists a pooling equilibrium with both types of experts offering a non-contingent contract and for all separating equilibria a high-value expert offers a less contingent contract than a low-value expert.

Keywords: Signaling, expert, moral hazard, contingent fee

JEL Classification: D82, D86