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The Informativeness Principle Under Limited Liability

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  • Pierre Chaigneau
  • Alex Edmans
  • Daniel Gottlieb
Abstract
This paper shows that the informativeness principle does not automatically extend to settings with limited liability. Even if a signal is informative about effort, it may have no value for contracting. An agent with limited liability is paid zero for certain output realizations. Thus, even if these output realizations are accompanied by an unfavorable signal, the payment cannot fall further and so the principal cannot make use of the signal. Similarly, a principal with limited liability may be unable to increase payments after a favorable signal. We derive necessary and sufficient conditions for signals to have positive value. Under bilateral limited liability and a monotone likelihood ratio, the value of information is non-monotonic in output, and the principal is willing to pay more for information at intermediate output levels.

Suggested Citation

  • Pierre Chaigneau & Alex Edmans & Daniel Gottlieb, 2014. "The Informativeness Principle Under Limited Liability," NBER Working Papers 20456, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:20456
    Note: CF LE LS
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    References listed on IDEAS

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    Cited by:

    1. Edmans, Alex & Gottlieb, Daniel & Chaigneau, Pierre, 2014. "The Value of Informativeness for Contracting," CEPR Discussion Papers 10180, C.E.P.R. Discussion Papers.
    2. FOSCHI, Matteo; SANTOS-PINTO, Luís Pedro, 2017. "Subjective Performance Evaluation of Employees with Biased Beliefs," Economics Working Papers ECO 2017/08, European University Institute.
    3. Miguel Antón & Florian Ederer & Mireia Giné & Martin Schmalz, 2023. "Common Ownership, Competition, and Top Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 131(5), pages 1294-1355.
    4. Engert Andreas & Goldlücke Susanne, 2017. "Why Agents Need Discretion: The Business Judgment Rule as Optimal Standard of Care," Review of Law & Economics, De Gruyter, vol. 13(1), pages 1-38, March.
    5. Kelly Shue & Richard Townsend, 2016. "Growth through Rigidity: An Explanation for the Rise in CEO Pay," NBER Working Papers 21975, National Bureau of Economic Research, Inc.
    6. Alex Edmans & Xavier Gabaix, 2016. "Executive Compensation: A Modern Primer," Journal of Economic Literature, American Economic Association, vol. 54(4), pages 1232-1287, December.
    7. Donaldson, Jason Roderick & Piacentino, Giorgia, 2018. "Contracting to compete for flows," Journal of Economic Theory, Elsevier, vol. 173(C), pages 289-319.
    8. Heider, Florian & Calcagno, Riccardo, 2016. "Liquidity, Information Aggregation, and Market-Based Pay in an Efficient Market," CEPR Discussion Papers 11298, C.E.P.R. Discussion Papers.
    9. Bengt Holmström, 2017. "Pay for Performance and Beyond," American Economic Review, American Economic Association, vol. 107(7), pages 1753-1777, July.

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    More about this item

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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