Costless Information and Costly Verification: A Case for Transparency

Abstract

A principal has to take a binary decision. She relies on information privately held by an agent who prefers the same action regardless of his type. The principal cannot incentivize with transfers but can learn the agent’s type at a cost. Additionally, the principal privately observes a signal correlated with the agent’s type. Transparent mechanisms are optimal: the principal’s payoff is the same as if her signal was public. A simple cutoff form is optimal: favorable signals ensure the agent’s preferred action. Signals below this cutoff lead to the nonpreferred action unless the agent appeals. An appeal always triggers type verification.