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This paper studies monitoring in long-term self-enforcing relationships
with adverse selection and moral hazard. Monitoring is used
to screen low types by incentivising them to shirk. Once high types
have been identified, monitoring is used both to incentivise effort
from high types and to provide off-path (dis)incentives for low types
looking to build a reputation. This results in a key trade-off: providing
cost-efficient incentives to high types, versus screening low
types faster. The optimal contract uses probation after screening:
high types are excessively monitored to facilitate better screening.
Monitoring declines as the agent’s track record improves.
