Moral Hazard in the Revelation of Knowledge

Abstract

We formulate and solve the problem of optimal mechanism-design by a principal facing adverse selection and moral hazard from different sources. The parties’ decision problem is comprised of a publicly observable collective choice and a partially private social choice. As in agency with pure adverse selection, the individual rationality of the parties’ replies to a mechanism is characterized by the truth-telling, the participation, and the abstention conditions, but the communications of each party with the mechanism-designer are subject to moral hazard from the hidden actions taken by the rest. The Implementation Principle (Faynzilberg, 2000) remains valid: the designer’s focus on individually-rational knowledge-revealing mechanisms is without loss of optimality. Mediation of voluntary collective choice necessitates a departure from the received mechanism-design methodology, a detailed comparison with which is also provided.