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arXiv · 2605.01080

Principal-agent problems with adverse selection: A stochastic target problem formulation

Guillermo Alonso Alvarez·Ibrahim Ekren·Liwei Huang
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Abstract

We study a principal-agent problem with adverse selection, where the principal does not know the agent's true cost but must design a contract to optimize a specific criterion. Unlike standard screening frameworks that allow for self-selection, we assume the principal can only offer a unique contract. We show that the agent's optimization problem can be reformulated as a stochastic target problem. After characterizing the credible domain of this target problem, we show that the principal's objective can be solved as a stochastic optimal control problem with partial information and state constraints. The description of the credible domain also allows us to obtain the value of screening contracts.

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Guillermo Alonso Alvarez, Ibrahim Ekren, Liwei Huang. 2026-05-01. Principal-agent problems with adverse selection: A stochastic target problem formulation. https://arxiv.org/abs/2605.01080

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