Delegated Contracting and Corporate Hierarchies

31 Pages Posted: 19 Nov 2003

See all articles by Chongwoo Choe

Chongwoo Choe

Monash University - Department of Economics

In-Uck Park

University of Bristol

Date Written: November 2003

Abstract

In a typical corporate hierarchy, the manager is delegated the authority to make decisions that set directions for the organization, employ subordinates and contract with external suppliers. This paper explains when such delegation of authority can be optimal, using a model of a firm with three parties: the principal, the manager and the worker. In centralization with two two-tier hierarchies, the principal designs contracts for both agents. In delegation with a three-tier hierarchy, the principal directly contracts with a delegated agent who, in turn, contracts with the other agent. We identify an environment where the principal can benefit from delegating authority to the manager, but not to the worker. Beneficial delegation arises endogenously when delegation motivates the manager to acquire valuable information, which is used for better decision-making and more efficient incentive provision to the worker. We also show how total surplus is distributed in delegation vis-a-vis centralization, document comparative statics results regarding the benefits of delegation and the distribution of total surplus, and discuss when delegation is more likely to dominate centralization.

Keywords: Corporate hierarchies, centralization, delegation, optimal contract

JEL Classification: C72, D21, D82, L22

Suggested Citation

Choe, Chongwoo and Park, In-Uck, Delegated Contracting and Corporate Hierarchies (November 2003). Available at SSRN: https://ssrn.com/abstract=470382 or http://dx.doi.org/10.2139/ssrn.470382

Chongwoo Choe (Contact Author)

Monash University - Department of Economics ( email )

Department of Economics
PO Box 197
Caulfield East, Victoria 3145
Australia
+61 2 9903 1125 (Phone)
+61 2 9903 1128 (Fax)

In-Uck Park

University of Bristol ( email )

8 Woodland Road
Economics Dept
Bristol, BS8 1TN
United Kingdom
+44-117-3310814 (Phone)

HOME PAGE: http://www.efm.bris.ac.uk/eciup/

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