Micro-level dynamics in hidden action situations with limited information

Abstract: The hidden-action model provides an optimal sharing rule for situations in which a principal assigns a task to an agent who makes an effort to carry out the task assigned to him. However, the principal can only observe the task outcome but not the agent's actual action, which is why the sharing rule can only be based on the outcome. The hidden-action model builds on somewhat idealized assumptions about the principal's and the agent's capabilities related to information access. We propose an agent-based model that relaxes some of these assumptions. Our analysis lays particular focus on the micro-level dynamics triggered by limited access to information. For the principal's sphere, we identify the so-called Sisyphus effect that explains why the sharing rule that provides the agent with incentives to take optimal action is difficult to achieve if the information is limited, and we identify factors that moderate this effect. In addition, we analyze the behavioral dynamics in the agent's sphere. We show that the agent might make even more of an effort than optimal under unlimited access to information, which we refer to as excess effort. Interestingly, the principal can control the probability of making an excess effort via the incentive mechanism. However, how much excess effort the agent finally makes is out of the principal's direct control.