Sequential Screening with Type-Enhancing Investment

36 Pages Posted: 19 Apr 2019 Last revised: 26 Oct 2020

See all articles by Bin Liu

Bin Liu

The Chinese University of Hong Kong, Shenzhen

Jingfeng Lu

National University of Singapore (NUS) - Department of Economics

Date Written: October 24, 2020

Abstract

Due to the well-known efficiency--rent extraction trade-off, the optimal mechanism in a pure screening environment (e.g., revenue maximization in auctions or cost minimization in procurement) typically calls for distortions in allocative efficiency when agents possess private information at the time of contracting. In this paper, we introduce first-stage type-enhancing hidden investment to a standard sequential screening model of procurement, and find that (1) with convex investment cost, mitigation of allocative distortion must arise; and (2) such mitigation can even be extreme with linear investment cost---procurement cost minimization must require social efficiency when the investment is sufficiently effective.

Keywords: Adverse selection, Dynamic mechanism design, Moral hazard, Endogenous type, Social welfare maximizing

JEL Classification: D44, D82, H57

Suggested Citation

Liu, Bin and Lu, Jingfeng, Sequential Screening with Type-Enhancing Investment (October 24, 2020). Available at SSRN: https://ssrn.com/abstract=3358742 or http://dx.doi.org/10.2139/ssrn.3358742

Bin Liu (Contact Author)

The Chinese University of Hong Kong, Shenzhen ( email )

Jingfeng Lu

National University of Singapore (NUS) - Department of Economics ( email )

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