On the Generalized Principal-Agent Problem : Decomposition and Existence Results

This paper addresses the class of generalized agency problems: situations in which adverse selection and moral hazard are jointly present. The complexity of the problem is increased by the interactions between the incentives associated with both types of private information. We present a decomposition of the principal's optimization problem under the first-order approach that sheds light on these interactions and significantly improves tractability. As applications, we (1) provide examples of the closed form solutions of the optimal contract, and (2) utilize the decomposition in the analysis of existence of the optimal contract. We identify a set of conditions that largely rely on economically appealing properties of production technology and ensure existence of the optimal contract. We also investigate the validity of the first-order approach in the generalized agency problem. We show that (1) the first-order approach is valid if the production technology satisfies the linear distribution function condition (LDFC) in actions and types, and (2) for more general production technologies the Mirrlees-Rogerson sufficient conditions need to be extended to include restrictions on aspects of the (endogenous) optimal contract itself