COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1698

Monitoring with Collective Memory:
Forgiveness for Optimally Empty Promises

David A. Miller and Kareen Rozen

June 2009
Revised October 2009
Revised April 2010

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.

Keywords: Teams, Contracting, Capacity constraints, Empty promises, Forgiveness, Bounded memory, Costly monitoring, Moral hazard, Dilbert principle

JEL Classification: C72, D03, D86