On the Interplay of Hidden Action and Hidden Information in Simple Bilateral Trading Problems

21 Pages Posted: 17 Dec 2002

See all articles by Patrick W. Schmitz

Patrick W. Schmitz

University of Cologne; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Abstract

A buyer and a seller can exchange one unit of an indivisible good. While producing the good, the seller can exert unobservable effort (hidden action). Then the buyer realizes whether his valuation is high or low, which stochastically depends upon the seller's effort level (hidden information). The parties are risk neutral, they can rule out renegotiation and write complete contracts. It is shown that the first best cannot be achieved whenever the ex post efficient trade decision is trivial. The second-best contract is characterized and an application of the model to the choice of risky projects is briefly discussed.

Keywords: hidden action, hidden information, moral hazard

JEL Classification: C72, C78, D23, D82

Suggested Citation

Schmitz, Patrick W., On the Interplay of Hidden Action and Hidden Information in Simple Bilateral Trading Problems. Available at SSRN: https://ssrn.com/abstract=353060 or http://dx.doi.org/10.2139/ssrn.353060

Patrick W. Schmitz (Contact Author)

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

HOME PAGE: http://schmitz.uni-koeln.de/index.php?s=mitarbeiter&t=schmitz

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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