The Theory of Incentives: The Principal-Agent Model

By Jean-Jacques Laffont; David Martimort | Go to book overview
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3
Incentive and
Participation Constraints
with Adverse Selection *

The main theme of chapter 2 was to determine how the fundamental conflict between rent extraction and efficiency could be solved in a principal-agent relationship with adverse selection. In the models presented in chapter 2, this conflict was relatively easy to understand because it resulted from the simple interaction of a single incentive constraint with a single participation constraint. A major difficulty of incentive theory in general, and adverse selection models in particular, lies in the numerous constraints imposed by incentive compatibility when one moves away from the simple models of chapter 2.1

In this chapter, we consider more complex contractual environments that have in common the fact that they raise further difficulties for the determination

1Even in those simple models, the optimal solution is only derived by first guessing which are the binding incentive and participation constraints and then checking ex post that the remaining constraints are really satisfied by the solution of the relaxed problem.

-82-

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