To understand the structure of the optimal contract it is useful to introduce the concept of information rent.
We saw in section 2.2 that, under complete information, the principal (who has all the bargaining power by assumption) is able to maintain all types of agents at their zero status quo utility level. Their respective utility levels U ∗ and U¯* at the first-best satisfy
Generally this will not be possible anymore under incomplete information, at least when the principal wants both types of agents to be active.
Take any menu of incentive feasible contracts and consider the utility level that a θ-agent would get by mimicking a θ¯-agent. By doing so, he would get
Even if the θ¯-agent utility level is reduced to its lowest utility level fixed at zero, i.e., , the θ-agent benefits from an information rent coming from his ability to possibly mimic the less efficient type. So, as long as the principal insists on a positive output for the inefficient type, q¯ > 0, the principal must give up a positive rent to a θ-agent. This information rent is generated by the informational advantage of the agent over the principal. The principal’s problem is to determine the smartest way to give up the rent provided by any given incentive feasible contract.
In what follows, we use the notations to denote the respective information rent of each type.
Source: Laffont Jean-Jacques, Martimort David (2002), The Theory of Incentives: The Principal-Agent Model, Princeton University Press.