Costly distortion of information in agency problems

Anecdotal evidence suggests that agents often spend resources distorting information transmitted to principals. We present a model where costly information distortion emerges as equilibrium behavior. The information structure we focus on is intermediate between (and encompasses) the cases of private information and public information: the agent can falsify the privately observed state at some cost. Although the principal can design contracts that induce no falsification, these may involve excessive information rents: falsification can be beneficial in spite of the waste of resources involved, because it helps reduce information rents. We examine how optimal contract and equilibrium payoffs change as the information structure ranges from private to public information.