Optimal Monitoring in Teams

This paper investigates the role of output quality control in a multi agent setting with moral hazard. The principal is in charge of a team of agents who produce the output. The marketing of this output can be either a success or entail huge losses. At the time of marketing the product, the principal is uncertain about its quality and can only observe an imperfect signal of it. This creates an ex post inefficiency (a successful project may not be undertaken) and a room for monitoring output's quality. In the paper, we describe when the principal will pay for this costly monitoring and its effect on agents' incentives to exert effort. We show that there are distortions ex ante in the contract offered by the principal and ex post in the continuation decision. The monitoring can only ensure ex post efficiency. The ex ante efficiency requires effort observability.