Information Management in Incentive Problems

The authors extend the standard procurement model to examine how an agent is optimally induced to acquire valuable planning information before he chooses an unobservable level of cost-reducing effort. Information acquisition concerns cause important changes in standard incentive contracts. Reward structures with extreme financial payoffs arise and super-high-powered contracts are coupled with contracts that entail pronounced cost sharing. However, if the principal can assign the planning and production tasks to two different agents, then all contracting distortions disappear and, except for forgone economies of scope, the principal achieves her most preferred outcome. Copyright 1997 by the University of Chicago.