Motivating Information Acquisition Under Delegation

Abstract

We study a model in which a principal delegates a choice between different actions to an expert. The return from each action is unknown but the expert can invest in acquiring (noisy) information before making her choice. The principal would like the expert to invest in information but this investment is unobservable and only the chosen action and its resulting payoff is contractible. We solve for the optimal contract and show that it induces a contrarian bias. As the main application, we explore a setting where an analyst in a brokerage house issues financial recommendations, and argue that our findings are supported by empirical evidence on the behavior of financial analysts.

Keywords: Information Acquisition, Compensation, Financial Analysts

JEL Classification: D82, D83, G24