Optimal contract and organizational design under moral hazard and adverse selection

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Contracts are essential for organizing economic activity, serving as tools to resolve conflicts of interest between parties, such as principals and agents. These conflicts are complicated by information asymmetry, which manifests in two forms: moral hazard, where the principal cannot monitor the agent, and adverse selection, where the agent has more information than the principal. Contract theory suggests that incentives can mitigate moral hazard, while a menu of contracts can help principals extract information in cases of adverse selection. This analysis explores optimal contracts under conditions of simultaneous moral hazard and adverse selection, as well as the impact of multiple agents on contract design. It argues that such scenarios support lean production and team-oriented structures, with the principal's ability to extract information depending on production substitutability. Additionally, the multi-agent context allows for examining hierarchical structures, revealing that certain organizations are superior due to differing informational contexts. This insight enhances our understanding of the firm as a nexus of contractual relationships among members with varying objectives.