Monitoring and Pay: An Experiment on Contract Design with Endogenous Monitoring

We implement a laboratory experiment in which a principal has to decide on monitoring intensity and pay to investigate whether they are complements or substitutes. Wage level, monitoring intensity, and consequently the desired enforceable effort level are jointly determined by the maximization problem of the firm. As a result, theoretically monitoring and pay should be complements. The between-treatment variation in our experiment is qualitatively in line with the normative prediction of the model under standard assumptions. Also the subject-specific variation indicates that monitoring and pay are considered as complements. Yet, we also find evidence for reciprocal behavior. Our data analysis shows, however, that it does not pay for the principal to only rely on the reciprocity of his agents.