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Optimal incentive contract with endogenous monitoring technology

Author

Listed:
  • Li, Anqi

    (Department of Economics, Washington University in St. Louis)

  • Yang, Ming

    (Fuqua School of Business, Duke University)

Abstract

Recent technology advances have enabled firms to flexibly process and analyze sophisticated employee performance data at a reduced and yet significant cost. We develop a theory of optimal incentive contracting where the monitoring technology that governs the above procedure is part of the designer's strategic planning. In otherwise standard principal-agent models with moral hazard, we allow the principal to partition agents' performance data into any finite categories and to pay for the amount of information the output signal carries. Through analysis of the trade-off between giving incentives to agents and saving the monitoring cost, we obtain characterizations of optimal monitoring technologies such as information aggregation, strict MLRP, likelihood ratio-convex performance classification, group evaluation in response to rising monitoring costs, and assessing multiple task performances according to agents' endogenous tendencies to shirk. We examine the implications of these results for workforce management and firms' internal organizations.

Suggested Citation

  • Li, Anqi & Yang, Ming, 2020. "Optimal incentive contract with endogenous monitoring technology," Theoretical Economics, Econometric Society, vol. 15(3), July.
    • Handle: RePEc:the:publsh:3130
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    References listed on IDEAS

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    Cited by:

    1. Federico Echenique & Anqi Li, 2022. "Rationally Inattentive Statistical Discrimination: Arrow Meets Phelps," Papers 2212.08219, arXiv.org, revised Nov 2023.
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    3. Achim, Peter & Knoepfle, Jan, 2024. "Relational enforcement," Theoretical Economics, Econometric Society, vol. 19(2), May.

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    More about this item

    Keywords

    Incentive contract; endogenous monitoring technology;

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • M15 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - IT Management
    • M5 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics

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