Nahum Melumad

Asymmetric Information and the Termination of Contracts in Agencies

Abstract:
I consider an agency model in which an agent, having acquired private post-contract predecision information, is allowed to breach the contract by paying the principal predetermined damages. The relationship of this model to the standard no-breach agency model is demonstrated and I argue that simplifying the analysis by restricting attention to no-breach models may yield incorrect conclusions. The shape of an optimal breach contract is then discussed and it is demonstrated that an optimal contract cannot include a severance payment. Next, I consider an alternative contractual arrangement whereby the agent may purchase access to private information prior to contracting. In this case, all the advantages of the breach institution are maintained, while possible exogenous (legal) restrictions on damage payments are avoided. The paper concludes by suggesting implications the study may have for legal research on contracts and judicial systems.

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