Working Paper: CEPR ID: DP7584
Authors: Patrick W. Schmitz
Abstract: Consider a seller and a buyer who write a contract. After that, the seller produces a good. She can influence the expected quality of the good by making unobservable investments. Only the seller learns the realized quality. Finally, trade can occur. It is always ex post efficient to trade. Yet, it may be impossible to achieve the first best, even though the risk-neutral parties are symmetrically informed at the contracting stage and complete contracts can be written. The second best is characterized by distortions that are reminiscent of adverse selection models (i.e., models with precontractual private information but without hidden actions).
Keywords: common values; hidden action; hidden information; holdup problem
JEL Codes: D23; D82; D86
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| seller's effort (D44) | quality of the good produced (L15) |
| quality of the good produced (L15) | trade efficiency (F14) |
| seller's effort (D44) | trade efficiency (F14) |
| hidden actions and private information (D82) | impossibility of achieving first-best outcomes (D61) |
| contract design (K12) | seller's effort (D44) |
| contract design (K12) | trade outcomes (F10) |