“Who Will Monitor the Monitor?,” D. Rahman (2010) | A Fine Theorem

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2024-11-05 12:00:17

In any organization, individuals can shirk by taking advantage of the fact that their actions are private; only a stochastic signal of effort can be observed, for instance. Because of this, firms and governments hire monitors to watch, imperfectly, what workers are doing, and to punish the workers if it is believed that the workers are taking actions contrary to what the bosses desire. Even if the monitor observed signals that are not available to the bosses, as long as that observation is free, the monitor has no incentive to lie. But what if monitoring is costly? How can we ensure the monitor has the right incentives to do his job? That is, who shall monitor the monitor? The answer, clearly, isn’t a third level of monitors, since this just pushes the problem back one more level.

In a very interesting new paper, David Rahman extends Holmstrom’s (who should share the next Nobel with Milgrom; it’s nuts they both haven’t won yet!) group incentives. The idea of group incentives is simple, and it works when monitor’s statements are verifiable. Say it costs 1 to monitor and the agent’s disutility from work is also 1. The principle doesn’t mind an equilibrium of (monitor, work), but better would be the equilibrium (don’t monitor, work), since then I don’t need to pay a monitor to watch my workers. The worker will just shirk if no one watches him, though. Group penalties fix this. Tell the monitor to check only one percent of the time. If he reports (verifiably) that the worker shirked, nobody gets paid. If he reports (verifiably) that the worker worked, the monitor gets $1.02 and the worker gets $100. By increasing the payment to the worker for “good news”, the firm can get arbitrarily close to the payoffs from the “never monitor, work” equilibrium.

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