Who and How? Adverse Selection and flexible Moral Hazard

TL;DR

This paper develops a comprehensive framework for designing incentive compatible mechanisms in environments with hidden types and actions, integrating adverse selection and moral hazard considerations.

Contribution

It introduces extended recommendation schedules and a generalized monotonicity condition for complete incentive compatibility characterization.

Findings

Provides a tractable characterization of incentive compatibility

Includes a generalized integral monotonicity condition

Demonstrates applicability across various contracting problems

Abstract

We characterize incentive compatible mechanisms in environments with hidden types and flexible hidden actions. Our approach introduces extended recommendation schedules that specify prescribed actions also off-path, after misreports. This approach yields a tractable and complete characterization of incentive compatibility, which includes a generalized integral monotonicity condition capturing the interaction between adverse selection and moral hazard. We demonstrate the usefulness of the characterization across a range of contracting problems.