This paper develops a principal-agent model of the firm in which shareholders give an incentive contract to a manager to limit the socially costly extraction of private benefits, and to induce truthful revelation of the manager’s type. We assume a type-dependent reservation utility. More precisely, the manager has an outside opportunity depending on the magnitude of his specific skills. Three regimes emerge, characterized by different levels of private benefits and wages. We find that type-dependent reservation utilities can improve the efficiency of the allocation from the social planner’s point of view, whereas shareholders experience ambiguous effects.
