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A Trickle-Down Theory of Incentives with Applications to Privatization and Outsourcing

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Abstract

The make-or-buy decision is analyzed in a three-layer principal-management-agent model. There is a cost-saving/quality tradeoff in effort provision. The principal faces the choice between employing an in-house management and contracting with an independent management; the cost-saving incentives facing the management are weaker in the former case. Cost-saving incentives trickle-down to the agent, affecting the cost-saving/quality tradeoff. It is shown that: weak cost-saving incentives to the management promotes quality if it is hard enough to meaurse; a more severe quality-control problem between the principal and the management, as well as a higher valuation of quality, makes an in-house management more attractive.

Suggested Citation

  • Andersson, Fredrik, 2004. "A Trickle-Down Theory of Incentives with Applications to Privatization and Outsourcing," Working Papers 2004:13, Lund University, Department of Economics.
  • Handle: RePEc:hhs:lunewp:2004_013
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    More about this item

    Keywords

    make-or-buy decision; multitask principal-agent problem; contracting out;

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures

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