IS NO NEWS BAD-NEWS - INFORMATION-TRANSMISSION AND THE ROLE OF EARLY WARNING IN THE PRINCIPAL-AGENT MODEL

The standard principal-agent model neglects the potentially important role of information transmission from agent to principal. We study opt imal incentive contracts when the agent has a private signal of the li kelihood of the project's success. We show that the principal can cost lessly extract this signal if and only if this does not lead her to in tervene in the project in any way that will influence its outcome. Int ervention undermines incentives by weakening the link between the agen t's initial effort and the project's outcome. If possible, the princip al commits not to cancel some projects with negative expected payoffs. To elicit early warning, contracts must reward agents for coming forw ard with bad news.