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Discussion Paper Details

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Title: Contracting With Synergies

Author(s): Alex Edmans, Itay Goldstein and John Zhu

Publication Date: July 2013

Keyword(s): complementarities, contract theory, influence, multiple agents, principal-agent problem, synergies and teams

Programme Area(s): Financial Economics

Abstract: This paper studies multi-agent optimal contracting with cost synergies. We model synergies as the extent to which effort by one agent reduces his colleague's marginal cost of effort. An agent's pay and effort depend on the synergies he exerts, the synergies his colleagues exert on him and, surprisingly, the synergies his colleagues exert on each other. It may be optimal to "over-work" and "over-incentivize" a synergistic agent, due to the spillover effect on his colleagues. This result can rationalize the high pay differential between CEOs and divisional managers. An increase in the synergy between two particular agents can lead to a third agent being endogenously excluded from the team, even if his own synergy is unchanged. This result has implications for optimal team composition and firm boundaries.

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Bibliographic Reference

Edmans, A, Goldstein, I and Zhu, J. 2013. 'Contracting With Synergies'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=9559