Are you a Good Employee or Simply a Good Guy? Inuence Costs and Contract Design

We develop a principal-agent model with a moral hazard problem in which the principal has access to a hard signal (the level of output) and a soft signal (the supervision signal) about the agent’s level of e¤ort. We show that the agent’s ability to manipulate the soft signal increases the cost of implementing the e¢ cient equilibrium, leading to wage compression when the in‡uence cost is privately incurred by the agent. When manipulation activities negatively a¤ect the agent’s productivity through the level of output, the design of in‡uence-free contracts that deter manipulation may lead to high-powered incentives. This result implies that high-productivity workers face incentive schemes that are more sensitive to hard evidence than those faced by their low-productivity counterparts. In that context, the principal will tolerate in‡uence for low-productivity workers but not for high-productivity workers. We also …nd that in the case of productivity-based costs, it may be optimal for the principal not to supervise the agent, even if supervision is costless (JEL D23, D82).