Should the Timing of Inspections be Predictable?
Provides theoretical guidance for regulators and managers on when to use predictable vs. random inspections to motivate effort in long-term projects.
The paper characterizes optimal inspection policies in a principal-agent model where the agent's effort affects breakthrough and breakdown rates. Predictable inspections are optimal when work primarily generates breakthroughs, while random inspections are optimal when work primarily prevents breakdowns.
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 affect the survival rate of the project, which determines his risk attitude over the timing of planned inspections.