No. 181: Information Acquisition under Moral Hazard and Disappointment Aversion

We propose a theory of information acquisition based on disappointment aversion. We extend a standard principal-agent model with moral hazard by assuming that the agent compares performance outcomes to reference points and experiences disappointment when the performance falls short of these reference points. We show that the optimal contract is characterized by a performance target, where the principal acquires additional information if the agent’s performance is below the target. Our findings suggest that the optimal performance target depends on the agent’s reference points and degree of disappointment aversion, as well as any contracting limitations faced by the principal. Overall, our theory provides a psychological explanation for the commonly observed conditional information acquisition where firms engage in lower-tail monitoring.