Optimal Incentive Contracts with Imperfect Information

The purpose of this paper is to develop a theory of contracts in situations characterized by a divergence of incentives between the two parties and asymmetric information (i.e., moral hazard) with special emphasis on how the possibilities for acquiring information affect the structure of the contract. In particular, we seek to explain the widespread use in areas such as employment and insurance of contracts in which the result of an imperfect (noisy) monitoring process is used to determine the schedule according to which one agent is compensated by another.