Optimal deterministic contracting mechanisms for principal-agent problems with moral hazard and adverse selection

Abstract

For the principal-agent problem with moral hazard and adverse selection we establish that within the collection of all measurable, deterministic contracting mechanisms satisfying the individual rationality and incentive compatibility constraints there exists one that is optimal for a risk averse principal contracting with a risk averse agent. In addition to demonstrating existence, one of the main contributions of the paper is to show that, in general, centralized contracting implemented via a contracting mechanism is equivalent to delegated contracting implemented via a contract menu. Thus, contracting can always be delegated to the agent without gain or loss to the principal. Based on this result, the existence of an optimal contracting mechanism for the principal-agent problem is established by showing that there exists an optimal contract menu for the equivalent delegated contracting problem.