Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2004:13: A Trickle-Down Theory of Incentives with Applications to Privatization and Outsourcing

Fredrik Andersson ()
Additional contact information
Fredrik Andersson: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, 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 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 attractive.

Keywords: make-or-buy decision; multitask principal-agent problem; contracting out

JEL-codes: D23; L22; L24

31 pages, March 24, 2004

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