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Optimal supervision with moral hazard

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  • Lin, Yu-Hsiu
  • Hu, Len-Kuo

Abstract

This paper adopts the principal-supervisor-agent hierarchy model pioneered by Tirole [Tirole, J., 1986. Hierarchies and bureaucracies: on the role of collusion in organizations. Journal of Law, Economics and Organization 2, 181-214] to analyze the optimal architecture of supervision. We consider a principal who encounters a double moral hazard problem. In particular, we examine the endogenously determined supervisory effort and the possibility of untruthful revelation of supervisor's message. The degree of accuracy for this endogenously chosen information architecture hinges upon the supervisory technology, the supervisor's reservation utility and the agent's production technology. Besides, though the principal's welfare would be lowered when the possibility of untruthful revelation is taken into account, we find that his desired supervisory effort level may be enhanced instead.

Suggested Citation

  • Lin, Yu-Hsiu & Hu, Len-Kuo, 2009. "Optimal supervision with moral hazard," Journal of Economic Behavior & Organization, Elsevier, vol. 71(2), pages 473-485, August.
    • Handle: RePEc:eee:jeborg:v:71:y:2009:i:2:p:473-485
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    References listed on IDEAS

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    1. M. Dewatripont & E. Maskin, 1995. "Contractual Contingencies and Renegotiation," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 704-719, Winter.
    2. Laffont, Jean-Jacques, 2001. "Incentives and Political Economy," OUP Catalogue, Oxford University Press, number 9780199248681.
    3. Antoine Faure-Grimaud & Jean-Jacques Laffont & David Martimort, 2003. "Collusion, Delegation and Supervision with Soft Information," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 70(2), pages 253-279.
    4. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, April.
    5. Tirole, Jean, 1986. "Hierarchies and Bureaucracies: On the Role of Collusion in Organizations," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 2(2), pages 181-214, Fall.
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    1. Len‐Kuo Hu & Daniel C. Lee, 2020. "Economic performance of state‐owned enterprises under the Chinese Communist Party's supervision: Some reflection on China's economic reform," Pacific Economic Review, Wiley Blackwell, vol. 25(4), pages 495-511, October.
    2. Díaz-Ríos, Claudia & Urbano-Canal, Nathalia & Ortegón-Penagos, Nataly, 2021. "How do national regulations for publicly subsidized private schools work in a decentralized context?," International Journal of Educational Development, Elsevier, vol. 84(C).

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