Contracting with imperfect commitment and noisy communication

This paper provides new analytical tools for studying principal-agent problems with adverse selection and limited commitment. By allowing the principal to use general communication devices we overcome the literature's common, but overly restrictive focus on one-shot, direct communication. In addition, general communication devices solve two fundamental problems of contracting with imperfect commitment: First, they allow us to identify the 'local downward' incentive constraints as the relevant ones if the agent's preferences satisfy a single-crossing property. Second, we show how one may restrict the cardinality of the message spaces of the communication device. An example illustrates our arguments and the suboptimality of one-shot, direct communication. (C) 2006 Elsevier Inc. All rights reserved.