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Organizational Design and Technology Choice with Nonbinding Contracts

  • Lars Stole

    (University of Chicago, GSB)

  • Jeffrey Zwiebel

    (Stanford University, GSB)

We present a new methodology for studying the problem of labor contracting within a firm's boundaries where contracts provide only a minimal commitment to wages and employment. Given the peculiar contractual incompleteness of labor contracts, the resulting wages and profits under an interesting class of complete information bargaining games distort the technological and organizational decisions facing the owner of the firm's capital. We show that in such settings where labor contracts are nonbinding, these decisions are distorted in an economically distinct way compared to the standard neoclassical firm. Among other things, we demonstrate that a firm with a nonbinding contractual basis will, relative to a neoclassical firm, (i) overemploy labor, (ii) underemploy capital, (iii) choose inefficient ``frontloaded'' technologies, (iv) de-emphasize scale and scope economies, and (v) inefficiently allocate labor across productive assets. We apply our analysis to product market competition, unionization, hierarchical management, and horizontal mergers.

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Paper provided by EconWPA in its series Game Theory and Information with number 9310001.

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Length: 34 pages
Date of creation: 12 Oct 1993
Date of revision: 13 Oct 1993
Handle: RePEc:wpa:wuwpga:9310001
Note: 34 pages, uuencoded postscript file
Contact details of provider: Web page: http://128.118.178.162

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  1. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
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