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USING COST OBSERVATION TO REGULATE A MANAGER WHO HAS A PREFERENCE FOR EMPIRE‐BUILDING
Author(s) -
BORGES ANA PINTO,
CORREIADASILVA JOÃO
Publication year - 2011
Publication title -
the manchester school
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.361
H-Index - 42
eISSN - 1467-9957
pISSN - 1463-6786
DOI - 10.1111/j.1467-9957.2010.02224.x
Subject(s) - unobservable , moral hazard , productivity , incentive , adverse selection , preference , payment , reimbursement , microeconomics , economics , business , actuarial science , finance , econometrics , health care , macroeconomics , economic growth
We study regulation of a manager who has a preference for empire‐building (high output), in the presence of moral hazard (unobservable effort) and adverse selection (unobservable productivity). We find that the optimal contract is linear in cost, being composed by a fixed payment plus a partial cost reimbursement. The preference for higher output reduces the manager's tendency to announce that his or her productivity is low, allowing a more powered incentive scheme (a lower fraction of the cost is reimbursed), which alleviates the problem of moral hazard.