Should the Timing of Inspections be Predictable?

TL;DR

This paper analyzes how the timing of inspections affects incentives in long-term principal-agent relationships, showing that predictable inspections motivate breakthroughs while random inspections prevent breakdowns.

Contribution

It characterizes the principal's optimal inspection policy based on whether work mainly produces breakthroughs or prevents breakdowns, highlighting the role of action-driven risk attitudes.

Findings

Predictable inspections are optimal when work mainly yields breakthroughs.

Random inspections are optimal when work mainly prevents breakdowns.

Agent's actions influence their risk attitude over punishment timing.

Abstract

A principal hires an agent to work on a long-term project that culminates in a breakthrough or a breakdown. At each time, the agent privately chooses to work or shirk. Working increases the arrival rate of breakthroughs and decreases the arrival rate of breakdowns. To motivate the agent to work, the principal conducts costly inspections. She fires the agent if shirking is detected. We characterize the principal's optimal inspection policy. Predictable inspections are optimal if work primarily generates breakthroughs. Random inspections are optimal if work primarily prevents breakdowns. Crucially, the agent's actions determine his risk attitude over the timing of punishments.