Working Paper: NBER ID: w24627
Authors: Francisco Espinosa; Debraj Ray
Abstract: Agents signal their type in a principal-agent model; the principal seeks to retain good agents. Types are signaled with some ambient noise. Agents can choose to add or remove additional noise at a cost. It is shown that monotone retention strategies, in which the principal keeps the agent if the signal crosses some threshold, are generically never equilibria. The main result identifies an equilibrium with a bounded retention zone, in which the principal is wary of both excessively good and excessively bad signals: she retains the agent if the signal is “moderate” and replaces him otherwise. The equilibria we uncover are robust to various extensions: non-normal signal structures, non-binary types, interacting agents, costly mean-shifting, or dynamics with term limits. We discuss applications to risky portfolio management, fake news and noisy government statistics.
Keywords: Principal-Agent Model; Noisy Signaling; Retention Strategies
JEL Codes: D72; D82; D86
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| agent's type (L85) | signal generated (L96) |
| signal generated (L96) | principal's retention decision (M51) |
| agent's type (L85) | principal's retention decision (M51) |
| noise levels chosen by agents (D79) | principal's retention decision (M51) |
| bounded retention strategies (C41) | principal's retention decision (M51) |
| extreme signals (C69) | principal's retention decision (M51) |