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Incentives and Coordination in Hierarchies

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Author Info
Dilip Mookherjee (Boston University)
Stefan Reichelstein (UC Berkeley)

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Abstract

The internal organization of large firms as well as procurement and regulation contexts frequently involve a hierarchical nexus of contracts, with substantial delegation of decision making across layers. Such hierarchical delegation of decision making creates problems of aligning incentives of vertically related agents, and coordinating the actions of different branches of the hierarchy. In a principal-agent setting with private information, it is shown that under certain assumptions (top-down contracting, observability of subcontracting outcomes, absence of limited liability constraints) the hierarchy can implement second-best allocations. Incentive problems are overcome via compensations that are linear in a measure of performance of the concerned department, defined as the difference between a measure of imputed revenues and procurement costs. The coordination problem is overcome by conditioning output targets and payments on cost reports submitted by other branches; despite this, agents' strategies are dominant with respect to the behavior of members of other branches. The result provides conditions for the lack of a `control loss' from hierarchical decentralization of decision making, owing to incentive or coordination problems.

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Publisher Info
Article provided by Berkeley Electronic Press in its journal Advances in Theoretical Economics.

Volume (Year): 1 (2001)
Issue (Month): advances/1/1 ()
Pages: 1009-1009
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Handle: RePEc:bep:theadv:v:1:y:2001:i:advances/1/1:p:1009-1009

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Related research
Keywords: hierarchies networks organization theory profit centers incentives coordination control loss

Find related papers by JEL classification:
D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights

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  1. Leopoldo Yanes & Kam Ki Tang & Evelyn Ng & Rodney Beard, 2005. "The hierarchical structure of a firm: a geometric approach," Economics Bulletin, Economics Bulletin, vol. 12(13), pages 1-7. [Downloadable!]
  2. Jonathan Treussard, 2005. "Life-Cycle Consumption Plans and Portfolio Policies in a Heath-Jarrow-Morton Economy," Boston University - Department of Economics - Working Papers Series WP2005-033, Boston University - Department of Economics. [Downloadable!]
  3. DEQUIEDT, Vianney & MARTIMORT, David, 2004. "Delegated Monitoring versus Arm's Length Contracting," IDEI Working Papers 265, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
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  4. Staffan Canback & Phillip Samouel & David Price, 2003. "Strategy and structure in interaction: What determines the boundaries of the firm?," Industrial Organization 0303003, EconWPA, revised 17 Mar 2003. [Downloadable!]
  5. FAURE-GRIMAUD, Antoine & LAFFONT, Jean-Jacques & MARTIMORT, David, 2003. "Collusion, Delegation and Supervision with Soft Information," IDEI Working Papers 167, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
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  6. Chongwoo Choe & In-Uck Park, 2003. "Delegated Contracting and Corporate Hierarchies," CEI Working Paper Series 2003-23, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University. [Downloadable!]
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  7. Yeon-Koo Che & Jinwoo Kim, 2005. "Robustly collusion-proof implementation," Discussion Papers 0506-12, Columbia University, Department of Economics. [Downloadable!]
  8. Sandeep Baliga & Tomas Sjostrom, 1998. "Decentralization and Collusion," Discussion Papers 1210, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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