Signaling by an informed service provider |
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Authors: | Frances Xu Lee Yuk‐fai Fong |
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Affiliation: | 1. Quinlan School of Business, Loyola University Chicago, Chicago, IL, USA;2. Department of Economics, Hong Kong University of Science and Technology, Clear Water Bay, NT, Hong Kong |
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Abstract: | We study a service provider, who, at the time of offering a contract, is better informed than the potential client. A service provider that is hired to increase the client's chance of a gain, an “enhancer,” may be better informed of whether the client has a big or small opportunity. A service provider that is hired to reduce the client's chance of a loss, a “problem solver,” may be better informed of whether the client has a big or small problem. We show that an enhancer predominantly offers a contingent contract, while a problem solver predominantly offers a flat fee due to their signaling incentives. This explains the differences in real‐world contracts and also provides a novel explanation for the existence of low‐powered incentive contracts. We evaluate the policy intervention that limits the contingent part of the service providers' contracts. |
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