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Discussion Paper

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We study optimal contracting in a team setting with moral hazard, where teammates promise to complete socially efficient but costly tasks. Teammates must monitor each other to provide incentives, but each team member has limited capacity to allocate between monitoring and productive tasks. Players incur contractual punishments for unfulfilled promises that are discovered. We show that optimal contracts are generally “forgiving” and players optimally make “empty promises” that they don’t necessarily intend to fulfill. As uncertainty in task completion increases, players optimally make more empty promises but fewer total promises. A principal who hires a team of agents optimally implements a similar contract, with profit-sharing and employment-at-will. When agents differ in their productivity, the model suggests a “Dilbert principle” of supervision: less productive players optimally specialize in monitoring the more productive players’ promises.

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