Son Ku Kim

Credibility and Monitoring: Outsourcing as a Commitment Device

This paper studies the nature of incentive contracts between a risk-neutral principal and a risk-neutral agent under the constraint that the agent’s liability is limited. A necessary and sufficient condition is derived for the existence of a first-best contract under this constraint, and a bonus-based contract is shown to be the most efficient contractual form. Implications of bonus contracts are also discussed.