DP12572 Commitment vs. Flexibility with Costly Verification

Author(s): Marina Halac, Pierre Yared
Publication Date: January 2018
Keyword(s): costly verification, escape clause, optimal delegation
JEL(s): D02, D82
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12572

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.