Dynamic Contracting with Flexible Monitoring

We study a principal's joint design of optimal monitoring and compensation schemes to incentivize an agent. In an otherwise standard dynamic contracting framework, the principal can flexibly allocate her limited monitoring capacity between seeking evidence that confirms or contradicts the agent's effort, as the basis for reward or punishment. When the agent's continuation value is low, the principal seeks only confirmatory evidence. When it exceeds a threshold, the principal seeks mainly contradictory evidence. Importantly, the agent's effort is perpetuated if and only if he is sufficiently productive.

Keywords: flexible monitoring, dynamic moral hazard

JEL Classification: D86, D82, G39, J33, M52

Suggested Citation: Suggested Citation

Dai, Liang and Wang, Yenan and Yang, Ming, Dynamic Contracting with Flexible Monitoring (December 29, 2024). Available at SSRN: https://ssrn.com/abstract=3496785 or http://dx.doi.org/10.2139/ssrn.3496785