Discussion Paper Details

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Title: Commitment vs. Flexibility with Costly Verification

Author(s): Marina Halac and Pierre Yared

Publication Date: January 2018

Keyword(s): costly verification, escape clause and optimal delegation

Programme Area(s): Industrial Organization

Abstract: A principal faces an agent who is better informed but biased towards higher actions. She can verify the agent's information and specify his permissible actions. We show that if the verification cost is small enough, a threshold with an escape clause (TEC) is optimal: the agent is allowed to choose any action below a threshold or request verification and the efficient action if sufficiently constrained. For higher costs, however, the principal may require verification only for intermediate actions, dividing the delegation set. TEC is always optimal if the principal cannot commit to inefficient allocations following the verification decision and result.

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Bibliographic Reference

Halac, M and Yared, P. 2018. 'Commitment vs. Flexibility with Costly Verification'. London, Centre for Economic Policy Research.