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Then the agent would have no reason not to tell what he knows. This is not as uncommon a case as one might think. Evaluators of projects, accountants who are to judge the veracity of financial statements, for instance, are paid on a non-contingent basis. Contingent fees would do little but create distorting incentives to report honestly what’s observed.
More than evaluation expertise is needed to make a straight salary contract undesirable. Three ways of introducing preference incongruities are commonly considered, The first one recognizes that investments require efforts by the agent that cannot be compensated directly, because of problems with observability. To motivate private expenditures, contingent fees based on what’s observable, for instance the output of the project, will be necessary. Such incentive schemes introduce risk preferences for the agent, assuming that the agent is risk averse or does not have enough financial resources to buy out the principal.
A second possibility is that the agent owns part of the project, say the idea, and is shopping around for an equity partner. Since the agent knows the value of the project better than the potential partner, there is a problem in deciding on the right price. A contingent fee schedule is a means by which ex ante asymmetries in information can be reduced.
Finally, a third case recognizes that the agent may have a direct interest in the project, contingent fees notwithstanding. One plausible reason is that the agent’s market value will depend on undertaking the project as well as on its outcome. Thus, investments commonly yield financial returns as well as human capital returns. Some kind of contract will be needed to align incentives more closely.
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