Risk sharing in procurement |
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| Affiliation: | 1. Department of Economics, University of Wisconsin-Madison, Madison, USA;2. Department of Economics and Management Science, ENS-Paris Saclay, 94230 Cachan, France;3. Department of Economics, University of Essex, Park, Colchester, CO4 3SQ, United Kingdom, and International Monetary Fund, Washington DC, USA;1. College of Business, University of Louisville, 2301 S. 3rd Street, Louisville, KY 40292, United States;2. Department of Economics, University of Southern California, 3620 S. Vermont Avenue, Los Angeles, CA 90089, United States;3. Department of Economics, Lingnan University, 8 Castle Peak Road, Tuen Mun, Hong Kong |
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| Abstract: | We introduce bilateral risk aversion into the mixed adverse selection - moral hazard model of Laffont and Tirole (1986). The presence of exogenous risk interacts with the adverse selection problem in interesting ways. In particular, we show that it is never optimal to present the firm with a fixed price contract, that the efficient firm typically bears more risk than the inefficient firm, and that an increase in exogenous risk may bring about a decrease in expected cost of the project. As a by-product, we also establish that the famous ‘no-distortion-on-the top’ result in adverse selection models relies on risk neutrality of the agent. |
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