Patrick W. Schmitz
Journal of Mathematical Economics, Vol. 46 (5), 2010, 807-816.
Abstract. A seller and a buyer write a contract. After that, the seller produces a good. She can influence the expected quality of the good by exerting unobservable effort. Only the seller learns the realized quality. Finally, trade can occur. It is always ex post efficient to trade. Yet, it may be impossible to achieve the first best, even though the risk-neutral parties are symmetrically informed at the contracting stage and complete contracts can be written. The second best is characterized by distortions that are reminiscent of adverse selection models (i.e., models with precontractual private information but without hidden actions).
The working paper version is available for download (CEPR Discussion Paper 7584).
The paper is available for download.