Angelucci, Charles and Russo, Antonio (2012) Moral Hazard in Hierarchies and Soft Information. TSE Working Paper, n. 12-343

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Abstract

We investigate the scope for supervisory activities in organizations in which
information is non-verifiable and opportunism severe. A principal-supervisor-agent
hierarchy is considered. Side-contracts between supervisor and agent may be reached
both before and after the agent has chosen his hidden action. We find that the supervisor
is useful if and only if appointed before the agent has chosen his action. We also show
that delegation of payroll authority is suboptimal. Finally, some insights concerning the
optimal design of verification activities are provided: when information is non-verifiable,
the supervisor should be employed as a monitor rather than as an auditor.