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Contracting With Synergies

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  • Edmans, Alex
  • Goldstein, Itay
  • Zhu, John

Abstract

This paper studies multi-agent optimal contracting with cost synergies. We model synergies as the extent to which effort by one agent reduces his colleague's marginal cost of effort. An agent's pay and effort depend on the synergies he exerts, the synergies his colleagues exert on him and, surprisingly, the synergies his colleagues exert on each other. It may be optimal to "over-work" and "over-incentivize" a synergistic agent, due to the spillover effect on his colleagues. This result can rationalize the high pay differential between CEOs and divisional managers. An increase in the synergy between two particular agents can lead to a third agent being endogenously excluded from the team, even if his own synergy is unchanged. This result has implications for optimal team composition and firm boundaries.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9559.

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Date of creation: Jul 2013
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Handle: RePEc:cpr:ceprdp:9559

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Related research

Keywords: complementarities; contract theory; influence; multiple agents; principal-agent problem; synergies; teams;

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  1. Nittai K. Bergman & Dirk Jenter, 2005. "Employee Sentiment and Stock Option Compensation," NBER Working Papers 11409, National Bureau of Economic Research, Inc.
  2. József Sákovics & Jakub Steiner, 2012. "Who Matters in Coordination Problems?," American Economic Review, American Economic Association, vol. 102(7), pages 3439-61, December.
  3. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn.
  4. repec:rje:randje:v:37:y:2006:2:p:376-390 is not listed on IDEAS
  5. Xavier Gabaix & Augustin Landier, 2006. "Why Has CEO Pay Increased So Much?," 2006 Meeting Papers 518, Society for Economic Dynamics.
  6. Marko Tervio, 2008. "The Difference That CEOs Make: An Assignment Model Approach," American Economic Review, American Economic Association, vol. 98(3), pages 642-68, June.
  7. Dessein, Wouter & Garicano, Luis & Gertner, Robert, 2007. "Organizing for Synergies," CEPR Discussion Papers 6019, C.E.P.R. Discussion Papers.
  8. Eyal Winter, 2006. "Optimal incentives for sequential production processes," RAND Journal of Economics, RAND Corporation, vol. 37(2), pages 376-390, 06.
  9. Simon Gervais & Itay Goldstein, 2007. "The Positive Effects of Biased Self-Perceptions in Firms," Review of Finance, European Finance Association, vol. 11(3), pages 453-496.
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