Contract Distortion and Information Search in Outsourcing under Asymmetric Information

Abstract

Asymmetries of information exist widely in outsourcing market with the development of global economic. The problem of adverse selection with asymmetric information about the agent's production cost in outsourcing of manufacturing industry is studied in the paper. The principal has asymmetric information about agents' production cost and is in inferior position while the agents have their private information and are in superior position. On the basis of the principal-agent theory, two kinds of models are presented respectively under symmetric and asymmetric information. The adverse selection model which can reveal the true cost type of the agent under asymmetric information is set up and the optimal contracts are gotten. The results show that the contracts can attain the objective of inciting the agents to tell truth. Then two kinds of models are compared. The studies we have performed show that the principal experiences his losses owing to the lack of information under asymmetric information. In addition, as the results of our analysis, we conclude that the lower-cost agent obtains extra informational rent besides his reservation utility but the higher-cost agent only gets his reservation utility. The inefficient agent's contract is distorted. Further, the principal's optimal information search interval is given. It is concluded that collecting the agent's private information before signing the contract and offering a menu of contracts are favorable to the principal. Moreover, the principal should weigh the information value and the information search cost. In the end, in view of the given data, the influences of the probability assessment of lower cost on outsourcing contracts are analyzed. The results indicate that there exists efficiency loss under asymmetric information. With the increase of probability assessment on lower cost, the distortion degree of the higher-cost agent's contract is higher, the lower-cost agent obtain less informational rent and profit of the principal under asymmetric information is closer to that under symmetric information