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Frequent monitoring in dynamic contracts

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  • Orlov, Dmitry

Abstract

I consider a dynamic principal-agent model in which the agent does not observe the quality of his output and the principal chooses how much to monitor the agent. Monitoring improves production outcomes but can reduce the agent's incentive to work if it uncovers bad performance and leads to punishing the agent. The optimal monitoring intensity is path dependent: an agent who performed poorly in the past is monitored less going forward to reduce the risk of early termination. Conversely, an agent who performed well is monitored more as his accumulated promised compensation provides a buffer against bad monitoring outcomes and reduces the associated penalties by deferring the pay-for-performance risk to states of the world in which termination costs are low.

Suggested Citation

  • Orlov, Dmitry, 2022. "Frequent monitoring in dynamic contracts," Journal of Economic Theory, Elsevier, vol. 206(C).
    • Handle: RePEc:eee:jetheo:v:206:y:2022:i:c:s0022053122001405
    DOI: 10.1016/j.jet.2022.105550
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    Cited by:

    1. Alireza Fallah & Michael I. Jordan, 2023. "Contract Design With Safety Inspections," Papers 2311.02537, arXiv.org.

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    More about this item

    Keywords

    Repeated moral hazard; Dynamic contracts; Monitoring; Communication; Performance evaluations; Interventions;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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