Working Paper: CEPR ID: DP1967
Authors: Antoine Faure-Grimaud; Jean-Jacques Laffont; David Martimort
Abstract: We propose a theory of supervision with endogenous transaction costs. A principle 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 hieracrchy'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 organizations.
Keywords: supervision; soft information; collusion; endogenous transaction costs
JEL Codes: D82; G14; G32; L51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk aversion of supervisors (D81) | optimal contract design (D86) |
| risk aversion of supervisors (D81) | agency costs (G34) |
| agency costs (G34) | distortions in output (C67) |
| precision of supervisor's information (D83) | principal's welfare (I39) |
| stakes of collusion (D74) | likelihood of collusion (L12) |
| risk preferences of supervisors (D81) | transaction costs (D23) |
| supervisory technology (L96) | transaction costs (D23) |