Scandinavian Working Papers in Economics

Working Paper Series,
Research Institute of Industrial Economics

No 784: A Trickle-Down Theory of Incentives with Applications to Privatization and Outsourcing

Fredrik Andersson ()
Additional contact information
Fredrik Andersson: Department of Economics, Postal: Lund University, P.O. Box 7082, S-220 07, Lund, Sweden

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 chooses between employing an in-house management and contracting with an independent management; the cost-saving incentives facing the management are, endogenously, weaker in the former case. Cost-saving incentives trickle down to the agent, affecting the cost-saving/quality trade-off. It is shown that weak cost-saving incentives to the management promote quality provision by the agent, and that a more severe quality-control problem between the principal and the management, as well as a higher valuation of quality, make an in-house management more attractive.

Keywords: Make-or-buy decision; Multitask principal-agent problem; Outsourcing

JEL-codes: D23; L22; L24

28 pages, January 7, 2009

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