Moral Hazard in Hierarchies and Soft Information

We investigate the scope for supervisory activities in organizations in which information is non-verifiable (i.e. soft) and opportunism severe. A principal-supervisor agent hierarchy is considered. Side-contracts between supervisor and agent may be reached both before and after the agent has chosen his hidden action. We find that the supervisor is useful if and only if appointed before the agent has chosen his action. The supervisor is instead useless if asked to verify the agent‘s action only once the latter is completed. We also show that delegation of payroll authority is suboptimal. Finally, some insights concerning the optimal design of verification activities are provided: when information is soft, the supervisor should be employed as a monitor rather than as an auditor.