"Partial monitoring, adverse selection, and the internal efficiency of the firm," International Journal of Industrial Organization Volume 20, Issue 8, October 2002, pages 1061-96.
JEL codes: H57, H51
Keywords: monitoring, productive efficiency, adverse selection
Abstract: This paper investigates an adverse selection model with monitoring of managerial effort. In contrast to the literature, we assume tht the manager can be punished only if his effort is below a certain level that is monitored by the principal. Surprisingly, the optimal labor contract may induce an equilibrium effort which is lower than in the standard model without monitoring. This result holds for any discrete distribution of managerial types. In the continuous type case, the optimal contracts for high-quality (low-quality) managers are purely output-dependent (effort-dependent). .