Working Paper: CEPR ID: DP2777
Authors: Elisabetta Iossa; Patrick Legros
Abstract: When today?s actions can affect tomorrow's value of an asset and when the principal does not have access to hard information, either about productive activity or monitoring activity, two incentive problems must be simultaneously solved: first, the ?ex-ante? moral hazard problem of inducing higher productive effort from the agent; second, the ?ex-post? problem of inducing auditing and revelation of information from the auditor. Somewhat surprisingly, the first best can be attained in the negative externality (higher effort decreases the expected future quality of the asset) case: it is enough for the principal to commit to reallocate the right to use the asset at the end of the first period.In the positive externality case (when higher effort increases the future expected quality of the asset) a change in the rights to use the asset is no longer sufficient for efficiency in the second best situation. Rather, auditing by a potential entrant becomes necessary and a mix of property rights reallocation and transfers is necessary to solve the two incentive problems. We show that the second best optimal takes the form of a generalized ?golden parachute? contract where for high outputs the agent is replaced by the third party and leaves with a fixed compensation.
Keywords: externality; golden parachutes; monitoring; regulation
JEL Codes: D62; D82; L33; L51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Threat of property rights reallocation (P14) | Agent effort (L85) |
| Higher effort from agent (L85) | Expected future quality of asset (negative externality) (D62) |
| Higher effort (D29) | Need for third-party auditing (positive externality) (D62) |
| Type of externality (D62) | Need for monitoring (E63) |
| Property rights reallocation + Monetary compensation (H13) | Address dual incentive problems (D82) |
| Periodic auction of resource rights (D44) | Address monitoring problems (E61) |