Working Paper Series
A Theory of Delegated Contracting
Abstract: Delegated contracting describes a widely observable agency
mode where a top principal, who has no direct access to a productive
downstream agent, hires an intermediary to forward a sub-contract with
specified output targets and payments. The principal makes the payment to
the intermediary contingent on production taking place; the intermediary is
protected by limited liability and paid a bonus. I characterize the optimal
grand-contract with a continuum of agent types by using optimal control
techniques with a scrap value function. Delegation proofness is reached
through paying the intermediary what she could obtain by deviating. This
rent is shown to be convex and increasing in the contracting space. There
is internal verification of the ex-post state to reach compliance. The
principal uses cutoff structures instead of additional output distortions.
A leftbound incentive alignment principle between principal and
intermediary applies. The paper so delivers a general analysis of the loss
of control in vertical hierarchies.
Keywords: Delegated contracting; Vertical hierarchies; Internal verification; Adverse selection; Limited liability; Cutoff structures; Leftbound incentive alignment; (follow links to similar papers)
JEL-Codes: D23; D73; L51; (follow links to similar papers)
24 pages, October 26, 2016
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