Optimal Monitoring Design

George Georgiadis (Northwestern Kellogg)
Balazs Szentes (London School of Economics)

Abstract: This paper considers a Principal–Agent model with hidden action in which the Principal can monitor the Agent by acquiring independent signals conditional on effort at a constant marginal cost. The Principal aims to implement a target effort level at minimal cost. The main result of the paper is that the optimal information-acquisition strategy is a two-threshold policy and, consequently, the equilibrium contract specifies two possible wages for the Agent. This result provides a rationale for the frequently observed single-bonus wage contracts.

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