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Using Cost Observation To Regulate A Manager Who Has A Preference For Empire‐Building


We study regulation of a manager who has a preference for empire-building (high output), in the presence of moral hazard (unobservable effort) and adverse selection (unobservable productivity). We find that the optimal contract is linear in cost, being composed by a fixed payment plus a partial cost reimbursement. The preference for higher output reduces the manager's tendency to announce that his or her productivity is low, allowing a more powered incentive scheme (a lower fraction of the cost is reimbursed), which alleviates the problem of moral hazard.

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Article provided by University of Manchester in its journal The Manchester School.

Volume (Year): 79 (2011)
Issue (Month): 1 (January)
Pages: 29-44

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Handle: RePEc:bla:manchs:v:79:y:2011:i:1:p:29-44
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