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Optimal Contracts with Random Auditing

Author

Listed:
  • Andrei Barbos

    (Department of Economics, University of South Florida)

Abstract

In this paper we study an optimal contract problem under moral hazard in a principal-agent framework where contracts are implemented through random auditing. This monitoring instrument reveals the precise action taken by the agent with some nondegenerate probability r, and otherwise reveals no information. We characterize optimal contracts with random perfect monitoring under several information structures that allow for moral hazard and adverse selection. We evaluate the effect of the intensity of monitoring, as measured by r, on the value of the optimal contract. We show that more intense monitoring always increases the value of a contract when the principal can commit to make payments even if the an evaluation reveals that the agent took an action not allowed by the terms of the contract. When such commitment is infeasible and in equilibrium the agent shirks under some realizations of his type, the value of a contract may decrease in r.

Suggested Citation

  • Andrei Barbos, 2015. "Optimal Contracts with Random Auditing," Working Papers 0215, University of South Florida, Department of Economics.
    • Handle: RePEc:usf:wpaper:0215
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    File URL: https://www.usf.edu/arts-sciences/departments/economics/documents/random_auditing118.pdf.pdf
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    Cited by:

    1. Barbos, Andrei, 2019. "Dynamic contracts with random monitoring," Journal of Mathematical Economics, Elsevier, vol. 85(C), pages 1-16.

    More about this item

    Keywords

    Optimal Contracts; Random Auditing; Commitment;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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