WHY AN INFORMED PRINCIPAL MAY LEAVE RENTS TO AN AGENT

This paper characterizes incentive contracts for the situation where a principal is privately informed about the technology governing an agency relationship. In contrast to a standard principal-agent relationship, it is shown that a principal who values effort highly will choose to induce effort by paying a high base wage and low bonus payments. Moreover, the equilibrium contract has the principal transferring rents to the agent even though contracting possibilities are unrestricted and both principal and agent are risk neutral. Consequently, the informed-principal framework is shown to provide a rational for the payment of efficiency wages.