Optimal Contracting Under Adverse Selection: The Implications of Mentalizing

Contemporary Economics, Vol. 9, No. 2, pp. 215-232, 2015

18 Pages Posted: 5 Sep 2015

See all articles by Jonatan Lenells

Jonatan Lenells

Royal Institute of Technology (KTH)

Diego Stea

Copenhagen Business School - Department of Strategic Management and Globalization

Nicolai J. Foss

Copenhagen Business School - Department of Strategy and Innovation

Date Written: June 30, 2015

Abstract

We study a model of adverse selection, hard and soft information, and mentalizing ability — the human capacity to represent others’ intentions, knowledge, and beliefs. By allowing for a continuous range of different information types, as well as for different means of acquiring information, we develop a model that captures how principals differentially obtain information on agents. We show that principals that combine conventional data collection techniques with mentalizing benefit from a synergistic effect that impacts both the amount of information that is accessed and the overall cost of that information. This strategy affects the properties of the optimal contract, which grows closer to the first best. This research provides insights into the implications of mentalizing for agency theory.

Keywords: Adverse selection, mentalizing, hard information, soft information, contract

JEL Classification: D82; D83

Suggested Citation

Lenells, Jonatan and Stea, Diego and Foss, Nicolai J., Optimal Contracting Under Adverse Selection: The Implications of Mentalizing (June 30, 2015). Contemporary Economics, Vol. 9, No. 2, pp. 215-232, 2015 , Available at SSRN: https://ssrn.com/abstract=2656090

Jonatan Lenells

Royal Institute of Technology (KTH) ( email )

Lindstedtsvägen 30-100 44
Stockholm
Sweden

Diego Stea

Copenhagen Business School - Department of Strategic Management and Globalization ( email )

Porcelænshaven 24
Frederiksberg, 2000
Denmark

Nicolai J. Foss (Contact Author)

Copenhagen Business School - Department of Strategy and Innovation ( email )

Kilen
Frederiksberg, 2000
Denmark

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