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Monitoring and Hierarchies: The Marginal Value of Information in a Principal-Agent Model

In a principal-agent model with pure moral hazard, the agent takes a costly action that has an uncertain outcome. If the principal observes the outcome but not the action, he can design a payment rule for the agent, based on the outcome, that provides the latter with appropriate incentives to act. If the two individuals have different attitudes toward risk and the agent has a reservation level of utility for accepting the "contract," there is a conflict between incentive provision and risk sharing, and the outcome is less efficient than if the principal could observe the agent's action costlessly. In this situation, any information about the agent's action, no mat-