We consider a principal who deals with a privately informed agent protected by
limited liability in a correlated information setting. The agent's technology is such that the fixed cost declines with the marginal cost (the type), so that countervailing incentives may arise. We show that, with high liability, the first-best outcome can be effected for any type if (1) the fixed cost is non-concave in type, under the contract that yields the smallest feasible loss to the agent; (2) the fixed cost is not very concave in type, under the contract that yields the maximum sustainable loss to the agent.
We further show that, with low liability, the first-best outcome is still implemented
for a non-degenerate range of types if the fixed cost is less concave in type than some
given threshold, which tightens as the liability reduces. The optimal contract entails pooling otherwise
