Information Asymmetry among Multiple Principals and Inefficiency within the Organization

Abstract

We develop a theoretical framework to investigate the effect of information asymmetry between the two principals on the common agent’s incentives to provide an effort. We find that the agent’s effort to the poorly-informed (PI) principal is optimal, while his effort to the well-informed (WI) principal is not. Given that the valuable resource, i.e., the agent’s effort, should flow into the person who has higher ability, our results imply that the asymmetric information between two principals generates an efficiency loss within the organization. In addition, we examine whether this inefficiency is attenuated by changes of the relative weight of the agent’s profit set to each principal. The result shows that unless the WI principal solely determines the agent’s profit, the efficiency loss within the organization does not disappear. This finding corroborates that as long as the PI principal exists within the organization, the inefficiency might be inevitable. Our research not only provides new insights to the agency literatures but also offers useful information regarding the efficiency of organizational structure.