DP7252 Gathering Information before Signing a Contract: Experimental Evidence

Author(s): Eva I Hoppe-Fischer, Patrick W. Schmitz
Publication Date: April 2009
Keyword(s): adverse selection, agency theory, experiment, information gathering
JEL(s): C72, C91, D82, D86
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7252

A central insight of agency theory is that when a principal offers a contract to a privately informed agent, the principal trades off ex post efficiency in the bad state of nature against a larger profit in the good state of nature. We report about an experiment with 508 participants designed to test whether this fundamental trade-off is actually relevant. In particular, we investigate settings with both exogenous and endogenous information structures. We find that theory is indeed a useful predictor for the relative magnitudes of the principals' offers, the agents' information gathering decisions, and the occurrence of ex post inefficiencies.