Working Paper: CEPR ID: DP10254
Authors: Helmut Bester; Matthias Dahm
Abstract: We study contracting between a consumer and an expert. The expert can invest in diagnosis to obtain a noisy signal about whether a low-cost service is sufficient or whether a high-cost treatment is required to solve the consumer?s problem. This involves moral hazard because diagnosis effort and signals are not observable. Treatments are contractible, but success or failure of the low-cost treatment is observed only by the consumer. Payments can therefore not depend on the objective outcome but only the consumer?s report, or subjective evaluation. A failure of the low-cost treatment delays the solution of the consumer?s problem by the high-cost treatment to a second period. We show that the first-best solution can always be implemented if the parties? discount rate is zero; an increase in the discount rate reduces the range of parameter combinations for which the first-best can be obtained. In an extension we show that the first-best is also always implementable if diagnosis and treatment can be separated by contracting with two different agents.
Keywords: credence goods; information acquisition; moral hazard; subjective evaluation
JEL Codes: D82; D83; D86; I11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| discount rate (E43) | feasibility of achieving first-best outcome (D61) |
| increase in discount rate (E43) | range of parameter combinations for first-best outcome (C61) |
| separation of roles in contracting (L14) | ability to mitigate moral hazard and subjective evaluation issues (G52) |
| delay costs and agent's diagnostic effort (C41) | effectiveness of contract designs (D47) |