Monitoring versus Incentives: Substitutes or Complements?

Dominique Demougin () and Claude Fluet ()

No 47, Cahiers de recherche CREFE / CREFE Working Papers from CREFE, Université du Québec à Montréal

Abstract: This paper analyzes the trade-off between monitoring and incentives in a principal-agent relationship with moral hazard. We derive general results on the optimal monitoring-incentives mix for the case where both parties are risk-neutral and the agent faces a limited liability constraint. We show that the prinicpal uses less monitoring and stronger incentives if the agent's liability limit is relaxed or if monitoring costs increase. To induce more effort on the part of the agent, the principal resorts to more monitoring or to stronger incentives, or both. In particular, there are cases where the cheapest way to induce more effort is to use lower powered incentives, but with much more precise monitoring.

Cet article analyse l'arbitrage entre la vérification et l'incitation dans un modèle de principal-agent caract´risé par du risque moral. Nous dérivons des résultats généraux pour le cas où les deux participants sont neutres aux risques et l'agent fait face à une contrainte budgétaire. Il est montré que le principal utilisera moins de vérifications et des incitations plus fortes si la contrainte budgétaire est relaxée ou si les coûts de vérification augmentent. Pous inciter plus d'efforts de la part de l'agent, il est montré que le principal pourrait utiliser soit plus de vérifications, soit plus d'incitations, soit plus des deux. En particulier, il est possible que la methode la moins coûteuse soit de réduire les incitants et de surcompenser en augmentant la précision et la vérification.

Keywords: moral hazard; principal-agent; limited liability; information systems (search for similar items in EconPapers)
JEL-codes: D82 (search for similar items in EconPapers)
Date: 1997-03
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Forthcoming in the European Economic Review

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