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The O‐ring theory of the firm

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  • Michael T. Rauh

Abstract

We develop an O‐ring production function characterized by specialization and division of labor and where shirking or negative shocks can have major adverse consequences. We show that when the principal can monitor individual output, the firm tends be large (potentially larger than first best), with a high degree of specialization and division of labor, weak incentives, and low pay as in traditional nonunion manufacturing. Moral hazard can only limit the size of the firm relative to the first best when the principal can only monitor team output, in which case the firm has the opposite characteristics.

Suggested Citation

  • Michael T. Rauh, 2018. "The O‐ring theory of the firm," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 27(1), pages 82-101, March.
    • Handle: RePEc:bla:jemstr:v:27:y:2018:i:1:p:82-101
    DOI: 10.1111/jems.12216
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