Economics - Research Publications

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Author: Bardsley, Peter × Author: Basov, Suren × Type: Preprint ×

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    A general model of coexisting hidden action and hidden information
    Basov, S. ; Bardsley, P. ( 2005-12)
    We consider a general agency model with coexisting hidden actionand hidden information. We prove that, with minor technical qualifications,independence of the production technology from the consumer type isnecessary and sufficient for welfare irrelevance of hidden action. Our resultclarifies and confirms the main conclusion drawn in the existing literatureon mixed models, that if the parties are risk neutral and the productiontechnology is not correlated with private information, then hidden action isirrelevant. However it makes it clear that even under risk neutrality this conclusiondoes not extend to the correlated case, which in practice occurs quitefrequently. We illustrate it with a realistic example where neither hiddenaction nor hidden information on their own lead to welfare losses, while theircombination does.Keywords and Phrases: hidden action, hidden information, Fredholmintegral equations of the first type.