On the Interplay of Hidden Action and Hidden Information in Simple Bilateral Trading Problems

A buyer and a seller can exchange one unit of an indivisible good. While producing the good, the seller can exert unobservable effort (hidden action). Then the buyer realizes whether his valuation is high or low, which stochasti-cally depends upon the seller’s effort level (hidden information). The parties are risk neutral, they can rule out renegotiation and write complete con-tracts. It is shown that the first best cannot be achieved whenever the ex post efficient trade decision is trivial. The second-best contract is character-ized and an application of the model to the choice of risky projects is briefly discussed. JEL Classification Numbers: C72, C78, D23, D82 ∗ I would like to thank Stefan Reichelstein for pointing out to me that this note, which is based on the third chapter of my Ph.D. dissertation, may be of some interest. I am also very grateful to an anonymous referee, Yeon-Koo Che, Anke Kessler, Georg Nöldeke, Stephanie Rosenkranz, Klaus Schmidt, Urs Schweizer, Dirk Sliwka and several seminar participants for helpful comments. This is the working paper version of the following article