Information Acquisition, Moral Hazard, and Rewarding for Bad News

Abstract

This paper analyzes a principal-agent problem with moral hazard where a principal searches for an opportunity of uncertain return, and hires an agent to evaluate the options available. The agent's effort affects the informativeness of a signal about an option's return. Based on the information provided by the agent, the principal decides whether to accept the option at hand. We derive the optimal contract in the static and dynamic versions of the model. We show sometimes the agent is rewarded for delivering `bad news' about the quality of an option. We characterize distortions (relative to the first-best case) on the implemented effort level and the optimal stopping decision. Also, we study the dynamics induced by the optimal contract.