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Moral Hazard with Counterfeit Signals

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  • Clausen, Andrew

Abstract

In many moral hazard problems, the principal evaluates the agent's performance based on signals which the agent may suppress and replace with counterfeits. This form of fraud may affect the design of optimal contracts drastically, leading to complete market failure in extreme cases. I show that in optimal contracts, the principal deters all fraud, and does so by two complementary mechanisms. First, the principal punishes signals that are suspicious, i.e. appear counterfeit. Second, the principal is lenient on bad signals that the agent could suppress, but does not.

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  • Clausen, Andrew, 2013. "Moral Hazard with Counterfeit Signals," SIRE Discussion Papers 2013-13, Scottish Institute for Research in Economics (SIRE).
    • Handle: RePEc:edn:sirdps:442
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    File URL: http://hdl.handle.net/10943/442
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    Cited by:

    1. Paulo Fagandini, 2018. "Hunting with two bullets: moral hazard with a second chance," Nova SBE Working Paper Series wp629, Universidade Nova de Lisboa, Nova School of Business and Economics.
    2. Nirav Mehta, 2019. "Measuring quality for use in incentive schemes: The case of “shrinkage” estimators," Quantitative Economics, Econometric Society, vol. 10(4), pages 1537-1577, November.

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