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The Hold-Down Problem and the Boundaries of the Firm: Lesson from a Hidden Action Model with Endogenous Outside Option

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Author Info

  • Schnedler, Wendelin

    () (University of Paderborn)

  • Sunde, Uwe

    () (University of Munich)

Abstract

This paper offers a rationale for limiting the delegation of (real) authority, which neither relies on insurance arguments nor depends on ownership structure. We analyse a repeated hidden action model in which the actions of a risk neutral agent determine his future outside option. Consequently, the agent can improve his future bargaining position, which gives the principal an incentive to retain sufficient control over the agent’s actions. Using respective one-period contracts, the principal can implement the efficient outcome while “selling the shop” to the agent is sub-optimal. This provides an argument for integration if the boundary of the firm is defined by control rights rather than the entitlement to revenues.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 464.

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Length: 28 pages
Date of creation: Mar 2002
Date of revision:
Handle: RePEc:iza:izadps:dp464

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Related research

Keywords: hidden action; moral hazard; endogenous outside option; authority; outsourcing;

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  1. Drew Fudenberg & Bengt Holmstrom & Paul Milgrom, 1987. "Short-Term Contracts and Long-Term Agency Relationships," Working papers 468, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Philippe Aghion & Jean Tirole, 1994. "Formal and Real Authority in Organizations," Working papers 95-8, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Marcet, A. & Marimon, R., 1998. "Recursive Contracts," Economics Working Papers eco98/37, European University Institute.
  4. Nöldeke, Georg & Schmidt, Klaus M., 1997. "Sequential Investments and Options to Own," CEPR Discussion Papers 1645, C.E.P.R. Discussion Papers.
  5. Fernandes, Ana & Phelan, Christopher, 2000. "A Recursive Formulation for Repeated Agency with History Dependence," Journal of Economic Theory, Elsevier, vol. 91(2), pages 223-247, April.
  6. Gene M. Grossman & Elhanan Helpman, 2002. "Integration Versus Outsourcing In Industry Equilibrium," The Quarterly Journal of Economics, MIT Press, vol. 117(1), pages 85-120, February.
  7. Ma, Ching-to Albert, 1991. "Adverse Selection in Dynamic Moral Hazard," The Quarterly Journal of Economics, MIT Press, vol. 106(1), pages 255-75, February.
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