Commitment vs. Flexibility with Costly Verification
56 Pages Posted: 8 Jan 2018
There are 2 versions of this paper
Commitment vs. Flexibility with Costly Verification
Date Written: January 2018
Abstract
A principal faces an agent who is better informed but biased towards higher actions. She can verify the agent's information and specify his permissible actions. We show that if the verification cost is small enough, a threshold with an escape clause (TEC) is optimal: the agent is allowed to choose any action below a threshold or request verification and the efficient action if sufficiently constrained. For higher costs, however, the principal may require verification only for intermediate actions, dividing the delegation set. TEC is always optimal if the principal cannot commit to inefficient allocations following the verification decision and result.
Keywords: costly verification, escape clause, optimal delegation
JEL Classification: D02, D82
Suggested Citation: Suggested Citation