Economic Theory

, Volume 26, Issue 4, pp 867–885

Optimal contracts in a dynamic costly state verification model

Research Article

Summary.

This paper describes optimal contracts in a dynamic costly state verification model with stochastic monitoring. An agent operates a risky project on behalf of a principal who can observe the project’s revenues at a cost. We show that an optimal contract exists such that, at any history, either the principal claims the project’s entire revenues or promises to claim nothing in the future. In particular, the agent’s expected income rises with time. Moreover, except in at most one period, the principal claims all revenues when audit occurs. We provide conditions under which all optimal contracts satisfy these properties.

Keywords and Phrases:

Dynamic contracts Theory of uncertainty and information Costly state verification Monitoring. 

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Copyright information

© Springer-Verlag Berlin/Heidelberg 2005

Authors and Affiliations

  1. 1.Research DepartmentEuropean Central BankFrankfurt a.M.Germany
  2. 2.Research DepartmentFederal Reserve Bank of DallasDallasUSA

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