Optimal Contracts with Privately Informed Agents and Active Principals

Abstract

This paper considers an optimal contracting problem between an informed risk-averse agent and a principal, when the agent needs to perform multiple tasks, and the principal is active, i.e. she can influence some aspect of the agency relationship. It discusses the optimality of action restrictions in the equilibrium menus of linear contracts showing that private information considerations add new trade-offs to the optimal contracts in the multitask setting. The paper also has novel implications for the capital budgeting literature that studies informational problems. In particular the nature of the private information, e.g. whether it affects the marginal value of investment, the value of the agent's effort choice, or potential interactions between effort and investment, plays a crucial role in the optimal contracts. It is shown that several standard features of the optimal contracts are altered once the principal can affect the agency relationship through its capital budget, as well as through the compensation package.