DP12872 Instrument-Based vs. Target-Based Rules

Author(s):	Marina Halac, Pierre Yared
Publication Date:	April 2018
Keyword(s):	delegation, mechanism design, Policy Rules, private information
JEL(s):	D02, D82, E58, E61
Programme Areas:	Industrial Organization, Monetary Economics and Fluctuations, Macroeconomics and Growth
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=12872

We develop a simple delegation model to study rules based on instruments vs. targets. A principal faces a better informed but biased agent and relies on joint punishments as incentives. Instrument-based rules condition incentives on the agent's observable action; target-based rules condition incentives on outcomes that depend on the agent's action and private information. In each class, an optimal rule takes a threshold form and imposes the worst punishment upon violation. Target-based rules dominate instrument-based rules if and only if the agent's information is sufficiently precise. An optimal hybrid rule relaxes the instrument threshold whenever the target threshold is satisfied.