Private monitoring, collusion, and the timing of information

Abstract

When a principal's monitoring information is private (nonverifiable), the agent should be concerned that the principal could misrepresent the information to reduce the agent's wage or collect a monetary penalty. Restoring credibility may lead to an extreme waste of resourcesthe so-called burning of money. A more realistic and efficient outcome is feasible when the private information arrives in time to rescale the agent's effort. Rescaling is more effective than pure monetary penalties because effort has different values to different parties whereas money is equally valuable to all parties. Furthermore, when rescaling is feasible, private monitoring is more efficient than public monitoring subject to collusion because nonmonetary penalties are ineffective to deter collusion.