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Private Monitoring, Collusion and the Timing of Information

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  • Fahad Khalil
  • Jacques Lawarrée
  • Troy J. Scott
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    Abstract

    When the information used by a principal to monitor an agent is private, and thus non-verifiable by a third party, the principal has a credibility issue with the agent. The agent should be concerned that the principal could misrepresent the information in order to collect a monetary penalty from him. Restoring credibility may lead to an extreme waste of resources—the so-called burning of money, where the monetary penalty is given away to a third party. We show that a more realistic and efficient outcome is feasible by exploiting the timing of private information. If the private information arrives before the agent has completed his effort, non-monetary tools like rescaling the project become optimal, and no money needs to be burned. We show that rescaling is more effective than pure monetary penalties because effort has different values to different parties, while money is equally valuable to all parties. An alternative way to solve the principal’s credibility problem is to certify the private signal and make it public. When collusion between the certifier and the agent is an issue, we uncover interesting similarities between private signals and public (certified) signals vulnerable to collusive manipulation. We show that certification of private information by a third party may not always be in the interest of the principal if this certification raises the specter of collusion.

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    File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2013/wp-cesifo-2013-11/cesifo1_wp4497.pdf
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    Bibliographic Info

    Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 4497.

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    Date of creation: 2013
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    Handle: RePEc:ces:ceswps:_4497

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    Related research

    Keywords: monitoring; unverifiable signal; certification; private communication; timing of information; collusion; non-monetary penalties; burning money;

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    References

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    1. Antoine Faure-Grimaud & Jean-Jacques Laffont & David Martimort, 2003. "Collusion, Delegation and Supervision with Soft Information," Review of Economic Studies, Wiley Blackwell, vol. 70(2), pages 253-279, 04.
    2. William Fuchs, 2005. "Contracting with Repeated Moral Hazard and Private Evaluations," Game Theory and Information 0511007, EconWPA.
    3. Kandori, Michihiro, 2002. "Introduction to Repeated Games with Private Monitoring," Journal of Economic Theory, Elsevier, vol. 102(1), pages 1-15, January.
    4. Tirole, Jean, 1986. "Hierarchies and Bureaucracies: On the Role of Collusion in Organizations," Journal of Law, Economics and Organization, Oxford University Press, vol. 2(2), pages 181-214, Fall.
    5. David Rahman, 2012. "But Who Will Monitor the Monitor?," American Economic Review, American Economic Association, vol. 102(6), pages 2767-97, October.
    6. Bentley MacLeod, 2001. "Optimal Contracting with Subjective Evaluation," Theory workshop papers 357966000000000036, UCLA Department of Economics.
    7. Celik, Gorkem, 2009. "Mechanism design with collusive supervision," Journal of Economic Theory, Elsevier, vol. 144(1), pages 69-95, January.
    8. Fahad Khalil & Jacques Lawarrée & Sungho Yun, 2010. "Bribery versus extortion: allowing the lesser of two evils," RAND Journal of Economics, RAND Corporation, vol. 41(1), pages 179-198.
    9. Faure-Grimaud, Antoine & Martimort, David, 2003. " Regulatory Inertia," RAND Journal of Economics, The RAND Corporation, vol. 34(3), pages 413-37, Autumn.
    10. Michihiro Kandori & Hitoshi Matsushima, 1998. "Private Observation, Communication and Collusion," Econometrica, Econometric Society, vol. 66(3), pages 627-652, May.
    11. Strausz, Roland, 2005. "Interim Information in Long Term Contracts," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 40, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
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