Moral Hazard with Counterfeit Signals

Andrew Clausen

Edinburgh School of Economics Discussion Paper Series from Edinburgh School of Economics, University of Edinburgh

Abstract: In many moral hazard problems, the principal evaluates the agent's performance based on signals which the agent may suppress and replace with counterfeits. This form of fraud may affect the design of optimal contracts drastically, leading to complete market failure in extreme cases. I show that in optimal contracts, the principal deters all fraud, and does so by two complementary mechanisms. First, the principal punishes signals that are suspicious, i.e. appear counterfeit. Second, the principal is lenient on bad signals that the agent could suppress, but does not.

Pages: 39
Date: 2013-06
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Citations: View citations in EconPapers (3)

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Working Paper: Moral Hazard with Counterfeit Signals (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:edn:esedps:225

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