10.7. Implicit contracts under asymmetric information. (Azariadis and Stiglitz, 1983.) Consider the model of Section 10.5. Suppose, however, that only the firm observes A. In addition, suppose there are only two possible values of A, AB and AG (AB < AG), each occurring with probability 1 2 .

We can think of the contract as specifying w and L as functions of the firm’s announcement of the state, and as being subject to the restriction that it is never in the firm’s interest to announce a state other than the actual one;

formally, the contract must be incentive-compatible.

(a) Is the efficient contract under symmetric information derived in Section 10.5 incentive-compatible under asymmetric information? Specifically, if A is AB , is the firm better off claiming that A is AG (so that C and L are given by CG and LG) rather than that it is AB ? And if A is AG, is the firm better off claiming it is AB rather than AG?