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Delegated Contracting and Corporate Hierarchies

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  • In-Uck Park
  • Chongwoo Choe

Abstract

In a typical corporate hierarchy, the manager is delegated the authority to make decisions that set directions for the organization, employ subordinates and contract with external suppliers. This paper explains when such delegation of authority can be optimal, using a model of a firm with three parties: the principal, the manager and the worker. In centralization with two two-tier hierarchies, the principal designs contracts for both agents. In delegation with a three-tier hierarchy, the principal directly contracts with a delegated agent who, in turn, contracts with the other agent. We identify an environment where the principal can benefit from delegating authority to the manager, but not to the worker. Beneficial delegation arises endogenously when delegation motivates the manager to acquire valuable information, which is used for better decision-making and more effcient incentive provision to the worker. We also show how total surplus is distributed in delegation vis-a-vis centralization, document comparative statics results regarding the benefits of delegation and the distribution of total surplus, and discuss when delegation is more likely to dominate centralization

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 14.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:latm04:14

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Keywords: Corporate hierarchies; centralization; delegation; optimal contract.;

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Cited by:
  1. Rafael Hortala-Vallve & Miguel Sanchez, 2005. "Hierarchic contracting," STICERD - Distributional Analysis Research Programme Papers 73, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  2. Miguel A. Sanchez & Rafael Hortala-Vallve, 2005. "Hierarchic contracting," LSE Research Online Documents on Economics 6548, London School of Economics and Political Science, LSE Library.
  3. Chongwoo Choe, 2006. "Optimal CEO Compensation: Some Equivalence Results," Journal of Labor Economics, University of Chicago Press, vol. 24(1), pages 171-201, January.

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