Signaling by an informed service provider

Abstract

© 2017 Wiley Periodicals, Inc. We study a service provider, who, at the time of offering a contract, is better informed than the potential client. A service provider that is hired to increase the client's chance of a gain, an “enhancer,” may be better informed of whether the client has a big or small opportunity. A service provider that is hired to reduce the client's chance of a loss, a “problem solver,” may be better informed of whether the client has a big or small problem. We show that an enhancer predominantly offers a contingent contract, while a problem solver predominantly offers a flat fee due to their signaling incentives. This explains the differences in real-world contracts and also provides a novel explanation for the existence of low-powered incentive contracts. We evaluate the policy intervention that limits the contingent part of the service providers' contracts.