OPTIMAL RESOURCE ROYALTIES WITH UNKNOWN AND TEMPORALLY INDEPENDENT EXTRACTION COST STRUCTURES

We study optimal nonrenewable resource royalty contracts when the extracting agent has private information on costs. This is a dynamic incentive problem in which the repeated relationship between the principal and the agent is constrained by initial reserves. Commitment is limited to one period and costs are intertemporally independent. Compared with full information extraction, information asymmetry shifts production to the future when the optimal contract requires exhaustion in two periods. When exhaustion by all types in two periods is not warranted, the effect on the terminal period is ambiguous and the output of even the lowest cost firm is always distorted.