DP9929 Delegation and Dynamic Incentives

Author(s): Dongsoo Shin, Roland Strausz
Publication Date: April 2014
Keyword(s): Agency, Delegation, Dynamic Incentives, Limited Commitment
JEL(s): D82, D86, L22
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9929

Using an agency model, we show how delegation, by generating additional private information, improves dynamic incentives under limited commitment. It circumvents ratchet effects and facilitates the revelation of persistent private information through two effects: a play-hardball effect, which mitigates an efficient agent's ratchet incentive, and a carrot effect which reduces an inefficient agent's take-the-money-and-run incentive. Although delegation entails a loss of control, it is optimal when uncertainty about operational efficiency is large. Moreover, delegation is more effective with production complementarity. We also consider different modes of commitment to yield insights into optimal organizational boundaries.