Bray Theory Workshop

Abstract: Recent advances in IT and data science give firms more flexibility to process and analyze the growing volume and variety of employee performance data at a reduced and yet significant cost. This paper develops a theory of optimal incentive contracting where the monitoring technology that governs the above described process is a subject of the contract designer's choice. In otherwise standard agency models with moral hazard, we allow the principal to partition the agent's raw performance data into any finite categories, at a cost that increases with the fine-grainedness of the information that the induced performance signal carries. Through analyzing the trade-off between the incentive cost and the monitoring cost, we show that the optimal monitoring technology features information aggregation, strict MLRP, the coexistence of individual and group monitoring among technologically similar firms, and the fine-tuning of the monitoring intensity across tasks according to the agent's tendency to shirk. We examine the implications of our results for employee monitoring and the internal organization of firms, and discuss how our work helps guide the design of incentive contract in the information age.