Asymmetric Priors in Agency Under Maximum-Entropy

Abstract

This article analyzes the agency relationship in a setting where principal and agent have asymmetric priors on output. These differing priors stem from distinct information sets regarding the (unknown) output distribution, being assumed that both principal and agent rely on the maximum-entropy principle to estimate the respective distributions. The main conclusions obtained are the following. (1) Additional information on output does not necessarily lead to an improved equilibrium. (2) If the principal holds an ex ante piece of private information, it may be optimal for her to hide it and design the agency contract ignoring the additional information. (3) If the agent holds an ex ante piece of information, the contract may fail to be incentive-compatible; in such a case both parties improve if the agent shares his information and the principal ascribes to it, which justifies the common prior assumption.