Working Papers, Department of Economics, Lund University
A Trickle-Down Theory of Incentives with Applications to Privatization and Outsourcing
Abstract: The make-or-buy decision is analyzed in a three-layer
principal-management-agent model. There is a cost-saving/quality tradeoff
in effort provision. The principal faces the choice between employing an
in-house management and contracting with an independent management; the
cost-saving incentives facing the management are weaker in the former case.
Cost-saving incentives trickle-down to the agent, affecting the
cost-saving/quality tradeoff. It is shown that: weak cost-saving incentives
to the management promotes quality if it is hard enough to meaurse; a more
severe quality-control problem between the principal and the management, as
well as a higher valuation of quality, makes an in-house management more
Keywords: make-or-buy decision; multitask principal-agent problem; contracting out; (follow links to similar papers)
JEL-Codes: D23; L22; L24; (follow links to similar papers)
31 pages, March 24, 2004
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