Credibility and Monitoring: Outsourcing as a Commitment Device

Abstract

We analyze an environment plagued by double moral hazard where the worker's effort level and the employer's monitoring level are not contractible. In such an environment, the employer tends to over-monitor thereby inducing low effort. To ease the latter problem, the employer may choose to outsource the activity specifically because it raises monitoring costs. As a result monitoring is reduced and incentives become more powerful. This choice is particularly likely when the worker's effort is an important factor in determining output. We provide some supportive evidence from the French water purification industry. There, difficult purification tasks tend to be outsourced, while easy ones are carried out by the municipalities.

Keywords: Incentive scheme, integration, outsourcing, credibility

JEL Classification: H2