Signaling by an informed service provider

Frances Xu Lee and Yuk‐fai Fong

Journal of Economics & Management Strategy, 2017, vol. 26, issue 4, 955-968

Abstract: We study a service provider, who, at the time of offering a contract, is better informed than the potential client. A service provider that is hired to increase the client's chance of a gain, an “enhancer,” may be better informed of whether the client has a big or small opportunity. A service provider that is hired to reduce the client's chance of a loss, a “problem solver,” may be better informed of whether the client has a big or small problem. We show that an enhancer predominantly offers a contingent contract, while a problem solver predominantly offers a flat fee due to their signaling incentives. This explains the differences in real‐world contracts and also provides a novel explanation for the existence of low‐powered incentive contracts. We evaluate the policy intervention that limits the contingent part of the service providers' contracts.

Date: 2017
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