Econometrica: Sep, 2020, Volume 88, Issue 5

Optimal Monitoring Design

https://doi.org/10.3982/ECTA16475
p. 2075-2107

George Georgiadis, Balazs Szentes

This paper considers a Principal–Agent model with hidden action in which the Principal can monitor the Agent by acquiring independent signals conditional on effort at a constant marginal cost. The Principal aims to implement a target effort level at minimal cost. The main result of the paper is that the optimal information‐acquisition strategy is a two‐threshold policy and, consequently, the equilibrium contract specifies two possible wages for the Agent. This result provides a rationale for the frequently observed single‐bonus wage contracts.

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