Incentive Contracts in Two-Sided Moral Hazards with Multiple Agents

Author: Al-Najjar, N.I.

Source: Journal of Economic Theory, Volume 74, Number 1, May 1997 , pp. 174-195(22)

Publisher: Academic Press

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The paper studies a contracting problem in which a principal enters in two-sided moral hazards with N independent agents. There are no technological or informational linkages among the N agency problems. Despite this independence, optimal incentive schemes essentially eliminate the principal's incentive problem when team size is large enough. Reputation-like effects appear in a static setting through an improved aggregation of information about the actions of the principal. One implication of this result is that it is generally suboptimal to require an agent's compensation to depend only on his own outcome. Another implication is the existence of purely informational economies of scale to increasing team size. Thus, the concentration of otherwise unrelated transactions in a single "firm" creates wealth through a more efficient use of information about the Principal's actions. The paper also shows that extremely simple statistical contracts are approximately optimal in large teams. The outcome of such contracts is observationally indistinguishable from standard principal-agent contracts. This provides a theoretical justification for using standard principal-agent contracts in environments that involve two-sided hazard in a fundamental way. Journal of Economic Literature Classification Numbers: D21, D23.

Document Type: Research Article

Affiliations: Department of Managerial Economics and Decision Sciences, J. L. Kellogg Graduate School of Management, Northwestern University, 2001 Sheridan Road, Evanston, Illinois, 60208

Publication date: May 1, 1997

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