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  5. Dynamic Screening and the Dual Roles of Monitoring

American Economic Journal:
Microeconomics

ISSN 1945-7669 (Print) | ISSN 1945-7685 (Online)

Dynamic Screening and the Dual Roles of Monitoring

  • Dhruva Bhaskar
American Economic Journal: Microeconomics (Forthcoming)

Abstract

This paper studies monitoring in long-term self-enforcing relationships with adverse selection and moral hazard. Monitoring is used to screen low types by incentivising them to shirk. Once high types have been identified, monitoring is used both to incentivise effort from high types and to provide off-path (dis)incentives for low types looking to build a reputation. This results in a key trade-off: providing cost-efficient incentives to high types, versus screening low types faster. The optimal contract uses probation after screening: high types are excessively monitored to facilitate better screening. Monitoring declines as the agent’s track record improves.

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