Monitoring of Performance in Organizational Contracting: The Case of Defense Procurement

This paper contains an agency-theoretic analysis of procurement contracts in which the government designs optimal linear contracts for a risk-averse supplier in the presence of moral hazard, private information, and imperfect monitoring. Optimal contracts deviate from first-best risk sharing. The direction of the deviation depends on t he relative severity of the moral hazard and private information problem s and on the precision of the monitor. In contrast to the usual result in the moral hazard literature, the government may, in some cases, prefer that the effort of the supplier be taxed. Choice of the precision of the monitor and the categories of costs covered by the monitor are also studied.