Flexible Monitoring, Double Moral Hazard, and Fixed-Wage Contracts
Oct 11, 2025
A principal ("she") monitors an agent's("his") hidden action by allocating attention to observe his performance publicly; however, her own attention allocation is also her hidden action that she cannot commit to, leading to a double moral hazard problem. We study this problem in an infinite-horizon model where the principal can commit to the compensation scheme to varying degrees, but not to the monitoring scheme. We show that the optimal contract is a fixed wage paired with termination upon publicly observed bad performance, regardless of the degree of commitment in compensation. Introducing a minimal commitment to monitoring yields a more efficient contract by rewarding publicly observed good performance, thereby strengthening the agent's incentives, lowering his continuation value, and improving the principal's payoff. These findings offer a novel perspective on the prevalence of fixed-wage contracts in practice and how it may relate to limited commitment power in monitoring.