Optimal Contract under Moral Hazard with Soft Information

I study a model of moral hazard with soft information: the agent alone observes the stochastic outcome of her action; hence the principal faces a problem of ex post adverse selection. With limited instruments the principal cannot solve these two problems independently; the ex post incentive for misr...

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Bibliographic Details
Published in:	American economic journal. Microeconomics Vol. 5; no. 4; pp. 55 - 80
Main Author:	Roger, Guillaume
Format:	Journal Article
Language:	English
Published:	Pittsburgh American Economic Association 01-11-2013
Subjects:	Accounting Adverse selection Analysis Auditing Audits Contract theory Economic theory Equilibrium Executive compensation Expected utility Financial audits Fines & penalties Fraud Incentives Limited liability Microeconomics Moral hazard Moral hazard models Studies Transfer functions
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Summary:	I study a model of moral hazard with soft information: the agent alone observes the stochastic outcome of her action; hence the principal faces a problem of ex post adverse selection. With limited instruments the principal cannot solve these two problems independently; the ex post incentive for misreporting interacts with the ex ante incentives for effort. This affects the shape and properties of the optimal contract, which fails to elicit truthful revelation in all states. In this setup audit and transfer become strategic complements; this is rooted in the nonseparability of the problem.
ISSN:	1945-7669 1945-7685
DOI:	10.1257/mic.5.4.55