The price of advice

Abstract

We develop a model of consulting (advising) where the role of the consultant is to reveal signals to her client that refine the client's original private estimate of the profitability of a project. Although the client can perfectly observe and evaluate these signals, the consultant may only be able to do the same imperfectly, or not at all. This captures the idea that the expert may not fully understand the impact of her advice on the client. We characterize the optimal contract between the consultant and her client. It is a menu consisting of pairs of transfers specifying payments between the two parties in case the project is undertaken by the client and in case it is not. The main result of the article is that in the optimal mechanism, the consultant obtains the same profit as though she could perfectly observe and evaluate the impact of the signals whose release she controls on the client's profit estimate. Copyright © 2007, RAND.