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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