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Random Inspections and Periodic Reviews: Optimal Dynamic Monitoring

Author

Listed:
  • Felipe Varas
  • Iván Marinovic
  • Andrzej Skrzypacz

Abstract

We study the design of monitoring in dynamic settings with moral hazard. An agent (e.g. a firm) benefits from reputation for quality, and a principal (e.g. a regulator) can learn the agent’s quality via costly inspections. Monitoring plays two roles: an incentive role, because outcomes of inspections affect agent’s reputation, and an informational role because the principal directly values the information. We characterize the optimal monitoring policy inducing full effort. When information is the principal’s main concern, optimal monitoring is deterministic with periodic reviews. When incentive provision is the main concern, optimal monitoring is random with a constant hazard rate.

Suggested Citation

  • Felipe Varas & Iván Marinovic & Andrzej Skrzypacz, 2020. "Random Inspections and Periodic Reviews: Optimal Dynamic Monitoring," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 87(6), pages 2893-2937.
    • Handle: RePEc:oup:restud:v:87:y:2020:i:6:p:2893-2937.
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    File URL: http://hdl.handle.net/10.1093/restud/rdaa012
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    Citations

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    Cited by:

    1. Liang, Yong & Sun, Peng & Tang, Runyu & Zhang, Chong, 2023. "Efficient resource allocation contracts to reduce adverse events," Other publications TiSEM 0bcf44d9-d0ac-4231-beaf-8, Tilburg University, School of Economics and Management.
    2. Rodivilov, Alexander, 2022. "Monitoring innovation," Games and Economic Behavior, Elsevier, vol. 135(C), pages 297-326.
    3. Orlov, Dmitry, 2022. "Frequent monitoring in dynamic contracts," Journal of Economic Theory, Elsevier, vol. 206(C).
    4. Kfir Eliaz & Ran Spiegler, 2023. "Capability Building in Sluggish Organizations," Management Science, INFORMS, vol. 69(3), pages 1703-1713, March.
    5. Iván Marinovic & Martin Szydlowski, 2022. "Monitoring with career concerns," RAND Journal of Economics, RAND Corporation, vol. 53(2), pages 404-428, June.
    6. Mayer, Simon, 2022. "Financing breakthroughs under failure risk," Journal of Financial Economics, Elsevier, vol. 144(3), pages 807-848.
    7. Achim, Peter & Knoepfle, Jan, 2024. "Relational enforcement," Theoretical Economics, Econometric Society, vol. 19(2), May.
    8. Andrei Barbos, 2022. "Optimal contracts with random monitoring," International Journal of Game Theory, Springer;Game Theory Society, vol. 51(1), pages 119-154, March.
    9. Alireza Fallah & Michael I. Jordan, 2023. "Contract Design With Safety Inspections," Papers 2311.02537, arXiv.org.
    10. Felix Zhiyu Feng & Wenyu Wang & Yufeng Wu & Gaoqing Zhang, 2023. "Ignorance Is Bliss: The Screening Effect of (Noisy) Information," Papers 2302.11128, arXiv.org, revised Aug 2024.
    11. Solan, Eilon & Zhao, Chang, 2021. "Dynamic monitoring under resource constraints," Games and Economic Behavior, Elsevier, vol. 129(C), pages 476-491.

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