Mitigating Non-Contractability with Interim Randomization

This paper studies interim randomization in contracting settings with multi-sided incentive problems. More specifically, we show that in a principal-agent model with auditing the principal mitigates a non-contractibility of auditing by conditioning the contract on a random signal that is revealed at an interim stage of play. Optimal contracts are therefore random. In contrast to existing literature on random contracts, interim randomization enables contracting parties to achieve allocations that lie outside the convex hull of the set of attainable allocations under deterministic contracting.