The role of the agent's outside options in principal-agent relationships

Imran Rasul and Silvia Sonderegger

Games and Economic Behavior, 2010, vol. 68, issue 2, 781-788

Abstract: We consider a principal-agent model of adverse selection where, in order to trade with the principal, the agent must undertake a relationship-specific investment which affects his outside option to trade, i.e. the payoff that he can obtain by trading with an alternative principal. This creates a distinction between the agent's ex ante (before investment) and ex post (after investment) outside options to trade. We investigate the consequences of this distinction, and show that whenever an agent's ex ante and ex post outside options differ, this may equip the principal with an additional tool for screening among different agent types, by randomizing over the probability with which trade occurs once the agent has undertaken the investment. In turn, this may enhance the efficiency of the optimal second-best contract.

Keywords: Adverse; selection; Randomization; Type-dependent; outside; options (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (8)

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Related works:
Working Paper: The Role of the Agent's Outside Options in Principal-Agent Relationships (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:gamebe:v:68:y:2010:i:2:p:781-788

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