2000 Volume 8 Issue 1-2 Pages 139-156
Usually a principal motivates an agent through performance information. This should be possible when the information is verifiable. Verifiable information means that the information can be observed by third parties so that the information can be used as a variable of a contract. But in practice, we can easily find cases in which performance information is not necessarily verifiable. In this article, I look for a way to motivate an agent by monitoring his effort, on the assumption that the performance information is not verifiable.
First of all, I show that if performance information is not verifiable, the principal can not have the first best solution without infinitely preparing a large penalty for the agent so that he does not shirk from his work. When the agent can not bear the penalty because of a restriction against his assets, the principal may need to guarantee that the agent would assume a limited liability. Secondly, I show that even though the principal must assume the agent's limited liability, there can be a profitable contract for both of them. Lastly, I show that though advanced information technology which enables the performance information to be verifiable, the monitoring system can be a better solution than the information system to motivate the agent.
The analysis proceeds as follows.In Section 1, the model is described. In Section 2, I analyze the model to examine the characteristics of the optimal solution. In the last Section, I give some concluding remarks.
