Technical Change, Moral Hazard, and the Decentralization Penalty

29 Pages Posted: 27 Jul 2020

See all articles by Thomas Marschak

Thomas Marschak

University of California, Berkeley - Haas School of Business

Dong Wei

University of California, Berkeley - Department of Economics

Date Written: July 23, 2020

Abstract

In a moral-hazard setting, we consider two modes of organizing a firm --- a Centralized mode and a Decentralized mode. In the Centralized mode, perfect monitoring ensures that the welfare-maximizing effort is chosen. In the Decentralized mode, monitoring is imperfect and a profit-driven Principal induces her favorite effort by appropriately rewarding the Agent. The loss in welfare due to decentralization is called the Decentralization Penalty..For certain common contract types, we study the behavior of the Decentralization Penalty in response to changes in the production technology. We find that as production technology improves, the Decentralization Penalty oscillates. The Penalty rises in all intervals where the Penalty changes continuously. After such an interval, there may be a sudden change in the Penalty, and, under reasonable assumptions on costs and expected revenues, the sudden change is a drop. While an improvement in monitoring technology always strengthens the case for the Centralized mode, advances in production technology may do the opposite.

Suggested Citation

Marschak, Thomas and Wei, Dong, Technical Change, Moral Hazard, and the Decentralization Penalty (July 23, 2020). Available at SSRN: https://ssrn.com/abstract=3659638 or http://dx.doi.org/10.2139/ssrn.3659638

Thomas Marschak (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

Dong Wei

University of California, Berkeley - Department of Economics ( email )

579 Evans Hall
Berkeley, CA 94709
United States

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