Monitoring Reduces Efficiency: Evidence from the Laboratory

Abstract

In a laboratory experiment, we investigate the delegation of real authority in the spirit of the seminal paper by Aghion and Tirole (1997). Agents need to spend effort to identify promising projects, and principals can invest in monitoring to overrule agents with some probability. Based on a simple model, we predict that, compared to the Subgame Perfect Equilibrium with payoff maximization, principals invest too much in monitoring, and that agents respond too strongly to higher monitoring. Both hypotheses are confirmed, and principals face high losses due to over-monitoring. As the behavioral preferences of principals and agents are reinforcing with respect to the losses from over-monitoring, we conclude that restricting the principals' right to interfere may often yield higher payoffs for both managers and their subordinates.

Keywords: Monitoring, delegation, control premium, laboratory experiment

JEL Classification: C91, D03, D22, D82, J30