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CRIEFF Discussion Paper Number 1007

Optimal contracting with private information on cost expectation and variability

Daniel Danau (University of St. Andrews) Annalisa Vinella (University of Bari)

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We study the screening problem that arises in a framework where, initially, the agent is privately informed about both the expected production cost and the cost variability and, at a later stage, he learns privately the cost realization. The specific set of relevant incentive constraints, and so the characteristics of the optimal mechanism, depend …finely upon the curvature of the principal’s marginal surplus function as well as the relative importance of the two initial information problems. Pooling of production levels is optimally induced with respect to the cost variability when the principal’s knowledge imperfection about the latter is sufficiently less important than that about the expected cost.

JEL codes: D81, D82, D86
Keywords: Cost uncertainty; Multidimensional screening; Sequential screening

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