ABSTRACT: Disclosure and monitoring policy are studied, where disclosure relates to information about the monitoring system. A moral hazard model is presented where employee monitoring occurs with some exogenous probability and the owner privately learns whether he will be monitoring before the employee chooses his productive action. Disclosure policy is an owner choice between revealing to the employee whether he will be monitoring before the action (Disclosure) or remaining silent (Secrecy). The results rely on the joint presence of risk aversion and limited liability. Risk aversion creates an efficiency/risk tradeoff where secrecy obtains risk-sharing benefits. Limited liability reduces these benefits, allowing preference for disclosure. Lower monitoring probabilities increase the risk premium required to obtain effort with secrecy. For small monitoring probabilities, disclosure is preferred even though less efficient production is achieved, because disclosure provides a greater risk-sharing benefit. For high monitoring probabilities, secrecy is preferred because it leads to greater efficiency despite a greater risk premium.
Limited liability and its moral hazard implications: the systemic inscription of instability in contemporary capitalism
