Project Characteristics, Incentives and Team Production
Forthcoming in Management Science
34 Pages Posted: 21 Nov 2014
Date Written: November 19, 2014
We develop a model to show how agency conflicts, free rider effects and monitoring costs interact to affect optimal team size and workers' incentive contracts. Team size increases with project risk, decreases with profitability, and decreases with monitoring costs as a proportion of output. Our predictions are consistent with empirical evidence that firm-specific risk has increased over time and average corporate earnings have declined, while firms' organizational structures have also flattened. The predicted effects of monitoring costs on team size are supported by evidence that improvements in information technology that are likely to lower monitoring costs lead to larger teams. Further, firms with relatively more intangible assets, where monitoring costs are likely to be higher, are smaller. Optimal incentive intensities decrease with risk and increase with profitability. The endogenous determination of team size accentuates the positive effects of a decline in risk and an increase in profitability on incentives.
Keywords: Teams, Incentives, Moral Hazard, Monitoring, Contracting, Production
JEL Classification: L22, L14, D21, D82, M11
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