Contracting for Information Acquisition

Abstract

This chapter considers a supply chain scenario where a producer employs a seller to sell a product over a single sales season. The seller is engaged in two types of activities, gathering market information and generating sales. The producer benefits from both of these activities. In particular, the market information improves the producer’s demand forecast and thus her production planning. However, both activities require the seller to exert costly effort. Employing a stylized principal-agent model, we characterize the optimal performance of forecast-based contracts and menus of linear contracts. While forecast-based contracts have been widely used in practice, the academic literature suggests that menus of linear contracts are superior when agents are costlessly endowed with private information about the market condition. This chapter discusses that the relative performance of these two classes of contracts is more nuanced than what the literature suggests. In particular, when information acquisition is costly, forecast-based contracts may outperform menus of linear contracts.