Frequent monitoring in dynamic contracts

Dmitry Orlov

Journal of Economic Theory, 2022, vol. 206, issue C

Abstract: I consider a dynamic principal-agent model in which the agent does not observe the quality of his output and the principal chooses how much to monitor the agent. Monitoring improves production outcomes but can reduce the agent's incentive to work if it uncovers bad performance and leads to punishing the agent. The optimal monitoring intensity is path dependent: an agent who performed poorly in the past is monitored less going forward to reduce the risk of early termination. Conversely, an agent who performed well is monitored more as his accumulated promised compensation provides a buffer against bad monitoring outcomes and reduces the associated penalties by deferring the pay-for-performance risk to states of the world in which termination costs are low.

Keywords: Repeated moral hazard; Dynamic contracts; Monitoring; Communication; Performance evaluations; Interventions (search for similar items in EconPapers)
JEL-codes: D82 D83 D86 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:206:y:2022:i:c:s0022053122001405

DOI: 10.1016/j.jet.2022.105550

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