An optimal incentives contract can induce the revelation of true costs in a partnership by
A)imposing penalties when costs are overstated
B)offering bonus payments when costs are verified
C)renewing the reliance relationship
D)linking revealed cost to the partner's foregone expected profits
E)enlisting third-party enforcement

Question

Quizplus · Accepted Answer

Linking revealed cost to the partner's foregone expected profits provides a strong incentive for partners to reveal their true costs because the contract ties these costs to the partner's potential earnings. If a partner's costs are lower than they reported, they will earn a greater share of the profits. If their costs are higher than reported, they will earn a smaller share of the profits. This creates a strong self-interested motive to disclose true costs since it directly affects their potential profits.

An Optimal Incentives Contract Can Induce the Revelation of True