interactive controls Whistle blower type arrangements are designed to eneourage revelation of substandard performance. The most simple example is where an employee is legally protected when disclosing fraud. Ralph also knows these games. Suppo~ an absentee owner wants to hire Ralph to supp ly some service. The diffieulty is Ralph' s eost is privately known to Ralph and this places the owner at a eontraeting disadvantage. So the owner also hires a boss whose job it is to eontrol Ralph.

If the boss works hani, all there is to know about the produetive setting will be learned and this will allow for perfunetory eontrol of Ralph. It the boss shirks, nothing will be learned. Working hard earries an incremental personal eost of 10 units, and the boss requires an expected utility of at least 30. So paying the boss 40 is part of an effieient arrangement (where we want the boss to work).

Continuing, we assume Ralph' s eost is either 30 or 80. In addition, Ralph's eost is eorrelated with the produetive environment. Output will be 45 or 50 units. The probability of 50 units is .8 if Ralph's eost is 30 and .6 if Ralph's eost is 80. Ralph is also risk averse.

The following scheme materializes. The owner hires the boss. Ralph and the boss simultaneously announce whether Ralph is high or low eost. If their announcements agree, the boss is paid 40 and Ralph is paid the announced eost. If their announcements disagree, each is paid the minimum amount of zero.

a] Verify this scheme works: an equilibrium is for the boss to work and Ralph's eost to be identitied. Ifthe boss works hard and plays fair, the best Ralph can do is be honest; and if Ralph is being honest, the best the boss can do is work hard and play fair.

b] Suppose the boss shirks and always says 80. What is the best Ralph ean do?

Is this an equilibrium? Are boss and Ralph better off? Is the owner pleased?

e] Try the following elaborate scheme. Boss announees Ralph's pay of 30 or 80.

If 30 is announced, Ralph may produce and be paid 30 or quit and work elsewhere.

If Ralph quits, the boss is paid zero. It Ralph works, the.boss is paid 40. Also, if 80 is announced, Ralph may produce and be paid 80 or may claim the eost really is 30. If Ralph produces, the boss is paid 40 and Ralph is paid 80. If Ralph cIaims 30, the boss is paid zero and Ralph is paid 79 pIus a modest bonus if the output is 50 units.

Verify that the equilibrium in this game between Ralph and the boss is for the boss to work and tell the truth, and for Ralph always to aequiesce and be paid according to the boss' cIaim.

d] The scheme in [e] above relies on Ralph's ability to blow the whistle on the boss. Of eourse, in equilibrium this does not happen. What control problems would be apparent from watehing the game be played? What would a ease writer observe in sueh a setting?

AppendixLO1