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Agency Costs and Innovation

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  • Holmström, Bengt

    (Yale University)

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    Abstract

    Stylized facts indicate that small firms are responsible for a disproportionate share of innovative research. There are many possible explanations for this facto The paper seeks to understand this phenomena as the outcome of an optimal assignment of tasks across individuals and organizations. It is shown that incentive costs associated with a given task depend on the total portfolio of tasks that an individual or an organization undertakes. Mixing, hard to measure activities (innovation) with easy to measure activities (routine) is particularly costly, since it will either lead to misallocation of attention across tasks or to misallocation of risk. Larger firms are at a comparative disadvantage in conducting highly innovative research, because of the costs associated with managing a heterogeneous set of tasks. It is further argued that optimal organizational responses to coordination and control of routine tasks will lead to bureaucratization within the firm and to financial constraints imposed by capital markets, both of which are hostile to innovation.

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    File URL: http://www.ifn.se/wfiles/wp/wp214.pdf
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    Bibliographic Info

    Paper provided by Research Institute of Industrial Economics in its series Working Paper Series with number 214.

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    Length: 40 pages
    Date of creation: Sep 1989
    Date of revision:
    Handle: RePEc:hhs:iuiwop:0214

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    Related research

    Keywords: Innovation; agency costs; efficient allocation; routine;

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    References

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    1. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
    2. Lazear, Edward P, 1989. "Pay Equality and Industrial Politics," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 561-80, June.
    3. Milgrom, Paul R., 1987. "employment contracts, influence activities and efficient organization design," Department of Economics, Working Paper Series qt6pf6c5j6, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    4. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March.
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