We provide general conditions under which principal-agent problems admit mechanisms that are optimal for the principal. Our result covers as special cases those in which the agent has no private information – i.e., pure moral hazard – as well as those in which the agent’s only action is a participation decision – i.e., pure adverse selection. We allow multi-dimensional actions and signals, as well as both …nancial and non-financial rewards. Beyond measurability, we require no a priori restrictions on the space of mechanisms. Consequently, our optimal mechanisms are optimal among all measurable mechanisms. A key to obtaining our result is to permit randomized mechanisms. We also provide conditions under which randomization is unnecessary.

This paper offers a new approach to the study of economic problems usually modeled as games of incomplete information with discontinuous payoffs. Typically, the discontinuities arise from indeterminacies (ties) in the underlying problem. The point of view taken here is that the tie-breaking rules that resolve these indeterminacies should be viewed as part of the solution rather than part of the description of the model. A solution is therefore a tie-breaking rule together with strategies satisfying the usual best-response criterion. When information is incomplete, solutions need not exist; that is, there may be no tie-breaking rule that is compatible with the existence of strategy profiles satisfying the usual best-response criteria. It is shown that the introduction of incentive compatible communication (cheap talk) restores existence. Copyright The Econometric Society 2002.