Optimal Contracts with Random Auditing

Andrei Barbos

No 215, Working Papers from University of South Florida, Department of Economics

Abstract: In this paper we study an optimal contract problem under moral hazard in a principal-agent framework where contracts are implemented through random auditing. This monitoring instrument reveals the precise action taken by the agent with some nondegenerate probability r, and otherwise reveals no information. We characterize optimal contracts with random perfect monitoring under several information structures that allow for moral hazard and adverse selection. We evaluate the effect of the intensity of monitoring, as measured by r, on the value of the optimal contract. We show that more intense monitoring always increases the value of a contract when the principal can commit to make payments even if the an evaluation reveals that the agent took an action not allowed by the terms of the contract. When such commitment is infeasible and in equilibrium the agent shirks under some realizations of his type, the value of a contract may decrease in r.

Keywords: Optimal Contracts; Random Auditing; Commitment (search for similar items in EconPapers)
JEL-codes: D82 D86 (search for similar items in EconPapers)
Pages: 60 pages
Date: 2015-04
References: Add references at CitEc
Citations: View citations in EconPapers (2)

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