Dominique Demougin

Monitoring versus incentives

Abstract This paper analyzes the trade-off between monitoring and incentives in a principal–agent relationship with moral hazard. We derive general results on the optimal monitoring – incentives mix for the case where both parties are risk-neutral and the agent faces a limited liability constraint. We show that the principal uses less monitoring and stronger incentives if the agents liability limit is relaxed or if monitoring costs increase. To induce more effort on the part of the agent, the principal resorts to more monitoring or to stronger incentives, or both. In particular, there are cases where the cheapest way to induce more effort is to use lower-powered money incentives, but with much more precise monitoring.

Contractual Design with Correlated Information Under Limited Liability

We examine contractual design in a principal-agent model under two forms of limited liability: non-negative constraints on the transfer payments to and the profits of the agent. We show that when limited liability is a binding constraint the principal cannot implement the first-best solution and the agent earns rents from private information. Limited liability is a binding constraint in the non-negative transfers model only when a signal is insufficiently responsive to type (inelastic). Further, as the production rule and profits are continuous in the type elasticity of the signal density function, the level of inefficiency is less than that which obtains with no signal. If a signal is sufficiently responsive to type (elastic) in this environment, then the principal can implement the first-best allocation and the value of the agents private information is zero.

Incentive Contracts and Efficient Unemployment Benefits

Several European countries have reformed their labor market institutions. Incentive effects of unemployment benefits have been an important aspect of these reforms. We analyze this issue in a principal-agent model, focusing on unemployment levels and labor productivity. In our model, a higher level of unemployment benefits improves the workers position in wage bargaining, leading to stronger effort incentives and higher output. However, it also reduces incentives for labor market participation. Accordingly, there is a trade-off. We analyze how changes in the economic environment such as globalization and better educated workers affect this trade-off.

Output and Wages with Inequality Averse Agents

We analyze a two-task work environment with risk-neutral but inequality averse individuals. For the agent employed in task 2 effort is verifiable, while in task 1 it is not. Accordingly, agent 1 receives an incentive contract which, due to his wealth constraint, leads to a rent that the other agent resents. We show that inequality aversion affects the optimal contracts of both agents. Greater inequality aversion reduces the effort, wage and payoff of agent 1, while the effects on the wage and effort of agent 2 depend on whether effort levels across tasks are substitutes or complements in the firms output function. However, more inequality aversion unambiguously decreases total output and therefore average labor productivity.

Inequity Aversion in Tournaments

We consider the cost of providing incentives through tournaments when workers are inequity averse and performance evaluation is costly. The principal never benefits from empathy between the workers, by he may benefit from their propensity for envy depending on the costs of assessing performance. More envious employees are preferred when these costs are high, less envious ones when they are low.

Declining Labor Shares and Bargaining Power: An Institutional Explanation

We model the design of labor market institutions in an economy characterized by moral hazard and irreversible investment. In this setting, the environment setting affects the bargaining power of labor. At the optimum the allocation of bargaining power balances the aforementioned frictions. We examine the impact of improved monitoring and investigate the implication upon labor share, effort and investment. The models predictions are consistent with recent decreasing labor shares and wages per effective labor units observed in most OECD countries. It is also consistent with rising labor productivity and declining ratio between effective labor and capital found in many of these countries.

Rules of proof, courts, and incentives

We analyze the design of legal principles and procedures for court decision making in civil litigation. The objective is the provision of incentives for potential tort-feasors to exert care when evidence is imperfect and may be distorted by the parties. Efficiency is consistent with courts adjudicating on the basis of the preponderance of evidence standard together with common law exclusionary rules. Inefficient equilibria may nevertheless also arise under these rules. Burden of proof guidelines are then useful as a coordination device. Alternatively, guidelines are unnecessary if courts are allowed a more active or inquisitorial role in contrast to that of passive adjudicator. Copyright (c)2008, RAND.

Moral Hazard and Bargaining Power

Abstract We introduce bargaining power in a moral hazard framework where parties are risk-neutral and the agent is financially constrained. We show that the same contract emerges if the concept of bargaining power is analyzed in either of the following three frameworks: in a standard principal-agent (P-A) framework by varying the agent’s outside opportunity, in an alternating offer game, and in a generalized Nash-bargaining game. However, for sufficiently low levels of the agent’s bargaining power, increasing it marginally does affect the equilibrium in the Nash-bargaining game, but not in the P-A model and in the alternating offer game.

Deterrence versus Judicial Error: A Comparative View of Standards of Proof

We argue that the common-law standard of proof, given the rules of evidence, does not minimize expected error as usually argued in the legal literature, but may well be efficient from the standpoint of providing maximal incentives for socially desirable behavior. By contrast, civil laws higher but somewhat imprecise standard may be interpreted as reflecting a trade-off between providing incentives and avoiding judicial error per se. In our model, the optimal judicial system has rules resembling those in the common law when providing incentives is paramount. When greater weight is given to avoiding error, the optimal system has civil-law features.

Ranking of information systems in agency models: an integral condition

Summary. We provide a condition for ranking of information systems in agency problems. The condition has a straightforward economic interpretation in terms of the sensitivity of a cumulative distribution with respect to the agents effort. The criterion is shown to be equivalent to the mean preserving spread condition on the likelihood ratio distributions.