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On the optimal use of loose monitoring in agencies

Author

Listed:
  • Qi Chen

    (Duke University)

  • Thomas Hemmer

    (Rice University)

  • Yun Zhang

    (George Washington University School of Business)

Abstract

We study the governance implications of firms being privately informed of their potential productivity before contracting with an agent to supply unobservable effort. We show that it can be optimal for high potential firms to have “loose monitoring” in the sense that the monitoring system is less perfect than what is implied by a standard agency model a la Holmstrom (The Bell J Econ 10:74–91, 1979). Loose monitoring is used to achieve separation among different types of firms such that firms with low potential do not have incentives to imitate contracts offered by high potential firms. Our findings imply that although loose monitoring may be a symptom of firms squandering scarce resources provided by investors, it can also arise as an optimal contracting arrangement.

Suggested Citation

  • Qi Chen & Thomas Hemmer & Yun Zhang, 2011. "On the optimal use of loose monitoring in agencies," Review of Accounting Studies, Springer, vol. 16(2), pages 328-354, June.
    • Handle: RePEc:spr:reaccs:v:16:y:2011:i:2:d:10.1007_s11142-011-9142-y
    DOI: 10.1007/s11142-011-9142-y
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts

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