Relying on information acquired by a principal

This paper analyzes situations in which a principal is able to privately gather information about a task after contracting with an agent. To benefit from this information, the principal must mitigate her own incentives not only to misreport information to the agent but also to shirk on gathering information. If information gathering costs are large, the principal will design a contract in which output levels are different from the efficient levels in each of the possible states. While the optimal contract appears to provide high-powered incentives to the agent, it is actually designed to mitigate the principal's own incentives to shirk on gathering information and to misreport. © 2005 Elsevier B.V. All tights reserved.