The Role of the Agent's Outside Options in Principal-Agent Relationships

Imran Rasul and Silvia Sonderegger

Bristol Economics Discussion Papers from School of Economics, University of Bristol, UK

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 equips 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 e¢ciency of the optimal second-best contract.

Keywords: adverse selection; randomization; type-dependent outside options. (search for similar items in EconPapers)
JEL-codes: D21 L14 (search for similar items in EconPapers)
Pages: 12 pages
Date: 2008-09
New Economics Papers: this item is included in nep-bec and nep-cta
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: The role of the agent's outside options in principal-agent relationships (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:bri:uobdis:08/605

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