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Hierarchic contracting

  • Rafael Hortala-Vallve
  • Miguel Sanchez

We analyze the contracting structure in a moral hazard setting with several agents whereoutput is produced jointly and is the only contractible variable. Since the salary of each agentis a function of all agents efforts, a positive externality arises between them. This externalityis not internalised by a centralised structure where the principal contracts directly with eachagent. Instead, we find that a hierarchic structure (i.e. the delegation of "contracting rights"from the principal to the agents) internalises the externality by making agents "residualclaimants". Consequently, the second best situation can be improved upon just by changingthe contracting structure of the principal-agents relationship. The analysis is relevant to theliterature on decentralisation, outsourcing, subcontracting and intra-firm organization.

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File URL: http://sticerd.lse.ac.uk/dps/darp/DARP73.pdf
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Paper provided by Suntory and Toyota International Centres for Economics and Related Disciplines, LSE in its series STICERD - Distributional Analysis Research Programme Papers with number 73.

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Date of creation: Sep 2005
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Handle: RePEc:cep:stidar:73
Contact details of provider: Web page: http://sticerd.lse.ac.uk/_new/publications/default.asp

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  7. Choe, Chongwoo, 2002. "Delegated Contracting and Corporate Hierarchies," CEI Working Paper Series 2002-7, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.
  8. Itoh Hideshi, 1993. "Coalitions, Incentives, and Risk Sharing," Journal of Economic Theory, Elsevier, vol. 60(2), pages 410-427, August.
  9. Itoh, Hideshi, 1991. "Incentives to Help in Multi-agent Situations," Econometrica, Econometric Society, vol. 59(3), pages 611-36, May.
  10. Lazear, Edward P & Rosen, Sherwin, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 841-64, October.
  11. Prendergast, Canice J, 1995. "A Theory of Responsibility in Organizations," Journal of Labor Economics, University of Chicago Press, vol. 13(3), pages 387-400, July.
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