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Erschienen in: Review of Accounting Studies 2/2011

01.06.2011

On the optimal use of loose monitoring in agencies

verfasst von: Qi Chen, Thomas Hemmer, Yun Zhang

Erschienen in: Review of Accounting Studies | Ausgabe 2/2011

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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.

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Fußnoten
1
For example, while in some labor markets Honda is competing for the same talent as Caterpillar, to the prospective employees it may be less than obvious which company offers the best overall opportunities. Yet Honda is Honda and Caterpillar is Caterpillar, and they are obviously different.
 
2
Also see Weiss (1990), which offers an excellent overview of the efficiency wage literature.
 
3
Ayra and Mittendorf (2005) show that optimal contracts may vary in order to screen agents’ talent. However, as discussed in Sect. 2.3.2, switching private information from the principal to agent in our set-up does not give rise to a noisy information system.
 
4
We acknowledge the potential for the existence of other equilibria than this fully separating one. We provide further detailed discussions on this issue after Proposition 1 in the next section.
 
5
This formulation assumes that the principal has the bargaining power, which implies that in a standard single type model, the principal would never (need to) provide the agent with more than his reservation utility. Our results are not sensitive to this assumption. See Sect. 2.3.2 for detailed discussion.
 
6
If firms can choose an equilibrium before they learn their types, they strictly prefer pooling. This can be easily established due to the agent’s risk aversion and the need for firms to (costly) signal. However, this commitment to pooling requires that firms resist the temptation to deviate after their types are privately known.
 
7
In a two-sided adverse selection setting, Cella (2005) finds that pooling always dominates separation. Our setting differs from his in two significant ways. First, our setting is a case of common value while his deals with private value. Second, we impose ex post IC and IR constraints while his pooling equilibrium is obtained under interim IC and IR constraints. Ex post IC and IR imply interim IC and IR but the reverse is not true.
 
8
Detailed proof for this section is available from the authors upon request.
 
9
Correspondingly, because the low type does not want to imitate the high type to begin with, adding noise in the high type’s contract only increases the principal’s cost to induce effort from the high type without added benefits.
 
10
We thank an anonymous referee for this observation.
 
11
To see this, note that PIC(L) strictly satisfied means the low potential firm doesn’t want to choose this contract even if the agent believes such a contract is offered by the high potential firm with probability one.
 
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Metadaten
Titel
On the optimal use of loose monitoring in agencies
verfasst von
Qi Chen
Thomas Hemmer
Yun Zhang
Publikationsdatum
01.06.2011
Verlag
Springer US
Erschienen in
Review of Accounting Studies / Ausgabe 2/2011
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI
https://doi.org/10.1007/s11142-011-9142-y

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