Flexible Monitoring, Double Moral Hazard, and Fixed-Wage Contracts

Oct 11, 2025

Liang Dai, Yenan Wang, Ming Yang

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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.

Liang Dai

Liang Dai

Chinese University of Hong Kong, Shenzhen

Yenan Wang

Yenan Wang

Ming Yang

Ming Yang