Principle-agent problems with type-dependent outside options
The literature on adverse selection has until recently concentrated on the case where the agent's outside option is type-independent, implying that all types of agent receive the same payoff should no trade occur with the principal. Unfortunately, this assumption is not innocuous. If it is relaxed, the properties of the optimal contract can change dramatically. This thesis characterizes the impact of type-dependent outside options in three different settings. First, we explore the notion that a worker's prospects in the labour market may be influenced by his employment history. Under these circumstances, employers may incentivise their employees by randomizing over the probability with which current employees are retained. We identify a set of sufficient conditions for this to be the case in a two-period employment relationship, where the employee's ability is private information and both parties are risk-neutral. Although randomization is seldom observed in the real world, our results suggest that employers may optimally introduce some ambiguity over the conditions that need to be fulfilled in order to be retained. Second, we study competition in price-quality menus within the context of an horizontally differentiated duopoly, where each firm also operates in a local, monopolistic market. It is assumed that the consumer's (unobservable) valuation for quality is determined by the nature of his preferences over horizontal (or brand) product characteristics. We find that, if competition between the two firms is sufficiently fierce: (1) the equilibrium quality schedule exhibits bunching and (2) the equilibrium contract features overprovision of quality for sufficiently low types. Thus, with respect to the monopoly setting, competition may introduce new types of distortions, namely upward distortions. Third, we analyze the conflict of interests that arises between employers and employees with respect to the adoption of innovations that change the nature of the skills relevant for production. If an employer decides to adopt a new technology, he will also replace his specialist workforce. Thus, although a current employee has access to superior information concerning the efficiency of the new technology, he also has an incentive to misreport it. We show that if (1) the employee's expected utility from alternative employment is lower when the new technology is superior and (2) the employer cannot commit to retain the employee if the new technology is adopted, no renegotiation-proof contract exists, which induces the employee to truthfully reveal his information. In the special case where the employee can ex-ante commit to make his information publicly available (commitment to transparency), access to external sources of information can result in the employer's choice of technology being less efficient than otherwise.