The Value of Pre-contract Information about an Agent's Ability in the Presence of Moral Hazard and Adverse Selection

53 Pages Posted: 28 Oct 2019

See all articles by Rajiv D. Banker

Rajiv D. Banker

Temple University - Department of Accounting

Masako N. Darrough

Baruch College - CUNY

Shaopeng Li

affiliation not provided to SSRN

Lucas Threinen

Independent

Date Written: October 18, 2019

Abstract

We analyze the expected value of information about an agent's type in the presence of moral hazard and adverse selection. Information about the agent's type enables the principal to sort/screen agents of different types. The value of the information decreases in the variability of output and the agent's risk aversion, two factors that are typically associated with the severity of the moral hazard problem. However, the value of the information about agent type first increases but ultimately decreases in the severity of adverse selection. The decrease comes about because the means available to the principal to induce effort — namely, the pay-performance sensitivity — must also be used to sort/screen agents, and these two goals conflict. This decline in value occurs despite the monotonically increasing importance of the information in determining the principal's expected profits. Further, we show that the peak value of information occurs at a predictable level of adverse selection. These results imply that over some range, the importance of the information will be increasing, while the value of the information will be simultaneously decreasing, in the severity of adverse selection.

Keywords: Principal and Agent, Pre-contract Information, Moral Hazard, Adverse Selection

JEL Classification: D82, J33, M52

Suggested Citation

Banker, Rajiv D. and Darrough, Masako N. and Li, Shaopeng and Threinen, Lucas, The Value of Pre-contract Information about an Agent's Ability in the Presence of Moral Hazard and Adverse Selection (October 18, 2019). Available at SSRN: https://ssrn.com/abstract=3472106 or http://dx.doi.org/10.2139/ssrn.3472106

Rajiv D. Banker

Temple University - Department of Accounting ( email )

Philadelphia, PA 19122
United States

Masako N. Darrough (Contact Author)

Baruch College - CUNY ( email )

One Bernard Baruch Way
New York, NY 10010
United States
646 312 3183 (Phone)
646 312 3161 (Fax)

Shaopeng Li

affiliation not provided to SSRN

Lucas Threinen

Independent

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