Credibility and Monitoring: Outsourcing as a Commitment Device

Authors


  • We thank an associate editor and two referees of JEMS for very useful comments. Demougin is grateful for hospitality and support of the University Nancy 2 and the BETA. Furthermore, financial support by the Deutsche Forschungsgemeinschaft under grant DE 1169/1-1 is gratefully acknowledged.

Abstract

We analyze an environment plagued by double moral hazard where the agent’s effort level and the principal’s precision in monitoring are not contractible. In such an environment, the principal tends to over-monitor thereby inducing low effort. To ease the latter problem, the principal may choose to increase monitoring costs by outsourcing the activity. As a result equilibrium monitoring is reduced and incentives become more powerful. This choice is particularly likely when the worker’s effort is an important factor in determining output.

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