On the optimal use of loose monitoring in agencies

Qi Chen (), Thomas Hemmer () and Yun Zhang ()
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Qi Chen: Duke University
Thomas Hemmer: Rice University
Yun Zhang: George Washington University School of Business

Review of Accounting Studies, 2011, vol. 16, issue 2, No 5, 328-354

Abstract: Abstract We study the governance implications of firms being privately informed of their potential productivity before contracting with an agent to supply unobservable effort. We show that it can be optimal for high potential firms to have “loose monitoring” in the sense that the monitoring system is less perfect than what is implied by a standard agency model a la Holmstrom (The Bell J Econ 10:74–91, 1979). Loose monitoring is used to achieve separation among different types of firms such that firms with low potential do not have incentives to imitate contracts offered by high potential firms. Our findings imply that although loose monitoring may be a symptom of firms squandering scarce resources provided by investors, it can also arise as an optimal contracting arrangement.

Keywords: Pay; Performance measurement; Information system; Monitoring (search for similar items in EconPapers)
JEL-codes: D82 D86 J33 J41 (search for similar items in EconPapers)
Date: 2011
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DOI: 10.1007/s11142-011-9142-y

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