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A Theory of Supervision with Endogenous Transaction Costs

  • Antoine Faure-Grimaud
  • Jean-Jacques Laffont
  • David Martimort

We propose a theory of supervision with endogenous transaction costs. A principal delegates part of his authority to a supervisor who can acquire soft information about an agent's productivity. If the supervisor were risk-neutral, the principal would simply make the better informed supervisor residual claimant for the hierarchy's profit. Under risk-aversion, the optimal contract trades-off the supervisor's incentives to reveal his information with an insurance motive. This contract can be identified with the one obtained in a simple hard information model of hierarchical collusion with exogenous transaction costs. Now, transaction costs are endogenous and depend on the collusion stake, the accuracy of the supervisory technology and the supervisor's degree of risk-aversion. We then discuss various implications of the model for the design and management of organisations.

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Paper provided by Suntory and Toyota International Centres for Economics and Related Disciplines, LSE in its series STICERD - Theoretical Economics Paper Series with number 356.

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Date of creation: Jul 1998
Date of revision:
Handle: RePEc:cep:stitep:356
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  19. Galambos, Louis, 1995. "The Authority and Responsibility of the Chief Executive Officer: Shifting Patterns in Large US Enterprises in the Twentieth Century," Industrial and Corporate Change, Oxford University Press, vol. 4(1), pages 187-203.
  20. Rotemberg, Julio J, 1994. "Human Relations in the Workplace," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 684-717, August.
  21. Laffont, Jean-Jacques, 1990. "Analysis of Hidden Gaming in a Three-Level Hierarchy," Journal of Law, Economics and Organization, Oxford University Press, vol. 6(2), pages 301-24, Fall.
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