The Informativeness Principle Under Limited Liability

Alex Edmans, Daniel Gottlieb () and Pierre Chaigneau

No 10143, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper shows that the informativeness principle does not automatically extend to settings with limited liability. Even if a signal is informative about effort, it may have no value for contracting. An agent with limited liability is paid zero for certain output realizations. Thus, even if these output realizations are accompanied by an unfavorable signal, the payment cannot fall further and so the principal cannot make use of the signal. Similarly, a principal with limited liability may be unable to increase payments after a favorable signal. We derive necessary and sufficient conditions for signals to have positive value. Under bilateral limited liability and a monotone likelihood ratio, the value of information is non-monotonic in output, and the principal is willing to pay more for information at intermediate output levels.

Keywords: Contract theory; Informativeness principle; Limited liability; Options; Pay-for-luck; Principal-agent model; Relative performance evaluation (search for similar items in EconPapers)
JEL-codes: D86 J33 (search for similar items in EconPapers)
Date: 2014-09
New Economics Papers: this item is included in nep-cta, nep-hrm and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Working Paper: The Informativeness Principle Under Limited Liability (2014)
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