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Optimal Incentive Contract with Endogenous Monitoring Technology

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  • Anqi Li
  • Ming Yang

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.

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  • Anqi Li & Ming Yang, 2018. "Optimal Incentive Contract with Endogenous Monitoring Technology," Papers 1810.11471, arXiv.org, revised Nov 2019.
    • Handle: RePEc:arx:papers:1810.11471
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    References listed on IDEAS

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