Optimal contracts for lenient supervisors

We analyze optimal contracts in a hierarchy consisting of a principal, a supervisor and an agent. The supervisor is either neutral or altruistic towards the agent, but his preferences are private information. In a model with two supervisor types, we find that the optimal contract may be very simple, paying the supervisor a flat wage independent of his type and his evaluation of the agent's effort. Such a contract induces the neutral type of supervisor to report the agent's performance truthfully, while the altruistic type reports favorably independent of performance. Accordingly, overstated performance (leniency bias) may be the outcome of an optimal contract under informational asymmetries.

► The paper analyzes optimal contracts in a principal–supervisor–agent hierarchy.
► The supervisor is either neutral or altruistic towards the agent.
► His preferences are private information.
► The optimal contract may be very simple, paying the supervisor flat wage.
► Such contract leads to overstated performance by the supervisor (leniency bias).