The Optimisation Program of the Principal:

The principal offers a menu of contracts without knowing type of agent. Then, the principal's  optimisation  problem is  

We will assess the distributive impact of asymmetric information through the information rent. Using  the  information rents  we can  replace transfers in  the  principal's objective function as functions of information rents  and  outputs so that the new optimisation variables  are expressed as .

With  this change of variables,  the  principal's objective function can then be rewritten as

In this formulation, the first term denotes expected allocative efficiency, and the  second term  denotes  expected information  rent. It implies  that the principal accepts some distortions away  from efficiency in order  to decrease the agent's information rent. So we are looking for second best solutions. The incentive constraints (4.9) and (4.10), when seen in terms of information rents and outputs, are

Let us use superscript SB in these solutions  to represent second-best options.