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Discussion Paper Details

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Title: The Informativeness Principle Under Limited Liability

Author(s): Pierre Chaigneau, Alex Edmans and Daniel Gottlieb

Publication Date: September 2014

Keyword(s): contract theory, Informativeness principle, limited liability, options, pay-for-luck, principal-agent model and relative performance evaluation

Programme Area(s): Financial Economics and Labour Economics

Abstract: This paper shows that the informativeness principle does not automatically extend to settings with limited liability. Even if a signal is informative about effort, it may have no value for contracting. An agent with limited liability is paid zero for certain output realizations. Thus, even if these output realizations are accompanied by an unfavorable signal, the payment cannot fall further and so the principal cannot make use of the signal. Similarly, a principal with limited liability may be unable to increase payments after a favorable signal. We derive necessary and sufficient conditions for signals to have positive value. Under bilateral limited liability and a monotone likelihood ratio, the value of information is non-monotonic in output, and the principal is willing to pay more for information at intermediate output levels.

For full details and related downloads, please visit: https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10143

Bibliographic Reference

Chaigneau, P, Edmans, A and Gottlieb, D. 2014. 'The Informativeness Principle Under Limited Liability'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10143