Commitment vs. Flexibility with Costly Verification

56 Pages Posted: 8 Jan 2018

See all articles by Marina Halac

Marina Halac

Columbia University

Pierre Yared

Columbia University - Columbia Business School, Finance

Multiple version iconThere are 2 versions of this paper

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

Halac, Marina and Yared, Pierre, Commitment vs. Flexibility with Costly Verification (January 2018). CEPR Discussion Paper No. DP12572, Available at SSRN: https://ssrn.com/abstract=3098168

Marina Halac (Contact Author)

Columbia University ( email )

Pierre Yared

Columbia University - Columbia Business School, Finance ( email )

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Uris Hall
New York, NY 10027
United States

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