Monitoring Moral Hazard, Asymmetric Information, and Risk Sharing in Procurement Contracting, RAND Journal of Economics
This article characterizes the optimal procurement contract for a monopsonistic purchaser who contracts with a risk-averse supplier with private information about his costs and who contributes an unobservable effort. The costs incurred by the supplier may be uncertain, and the purchaser has access to a monitor of costs that may be subject to noise that complicates risk sharing. The purchaser prefers to respond to the observability problem with a fixed-price contract and to respond to the private information problem with a cost-plus contract. With uncertain costs and a perfect monitor the optimal contract relieves the supplier of some risk, and the purchaser prefers that the effort of the supplier be subsidized. With deterministic costs and a noisy monitor the optimal contract places risk on the supplier, and the purchaser may prefer that the effort of the supplier be taxed.
David Baron, David Besanko
Baron, David, and David Besanko. 1987. Monitoring Moral Hazard, Asymmetric Information, and Risk Sharing in Procurement Contracting. RAND Journal of Economics. 18(4): 509-532.