The Impact of Verifiability on Contracts

30 Pages Posted: 3 Apr 2000

See all articles by Dhananjay (Dan) K. Gode

Dhananjay (Dan) K. Gode

New York University (NYU) - Department of Accounting

Rajdeep Singh

University of Minnesota - Twin Cities - Carlson School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: February 2000

Abstract

We analyze the impact of verifiability on how signals about agents are used to mitigate adverse selection. We show that if signals are verifiable the observed practice of collecting information about agents before contracting is inferior to writing contingent contracts. This holds regardless of the agent's risk aversion, bounded penalties, or investigation costs. In fact, with risk-neutral agents, a principal can get first-best utility with contingent contracts. We further show that even unverifiable signals can be gainfully used in contingent contracts by removing a principal's incentives to distort signals or by removing an agent's incentives to demand verification.

JEL Classification: D82, J33, M41, M46

Suggested Citation

Gode, Dhananjay (Dan) K. and Singh, Rajdeep, The Impact of Verifiability on Contracts (February 2000). Available at SSRN: https://ssrn.com/abstract=219048 or http://dx.doi.org/10.2139/ssrn.219048

Dhananjay (Dan) K. Gode (Contact Author)

New York University (NYU) - Department of Accounting ( email )

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Rajdeep Singh

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