Principal agent model based design and outsourcing of information value

IT outsourcing allows a business to reduce the cost of IT service delivery and improve the quality of IT service by taking advantage of the service provider’s economics of scale and technical expertise. However, the successful outsourcing of IT service is hampered by lack of guidance on how to design incentive contracts to encourage performance of the service provider, especially in the presence of information asymmetry and incentive divergence. In this article, we identify and characterize two asymmetric information factors: asymmetric effort information and asymmetric capability information. Depending on whether the service provider’s effort information and capability information is symmetric or not, we consider three information scenarios and characterize optimal incentive contracts for each scenario. We also introduce the concept of information value to quantify the adverse effects of the two asymmetric information factors. The results provide theoretical support for designing incentive contracts that mitigate the adverse effects of asymmetric information, and recommend effective guidance for activities so as to reduce the degree of information asymmetry.