Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2007/26: Relative Performance Evaluation, Agent Hold-Up and Firm Organization

Ola Kvaløy () and Trond E. Olsen ()
Additional contact information
Ola Kvaløy: Norwegian School of Hotel Management, Dept. of Business Administration, University of Stavanger, Postal: University of Stavanger, Department of Business Administration, Norwegian School of Hotel Management, 4036 Stavanger, Norway
Trond E. Olsen: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: We analyze a situation where common noise makes compensation based on relative performance evaluation (RPE) desirable, but where the agents' ability to hold-up values ex post obstruct the implementation of optimal RPE schemes. The principal can take actions to constrain the agents' hold-up power by limiting their outside options and by protecting property rights, but once these actions are costly, a trade-off between incentive provision and agent control appears. The model contributes to the theory of the firm. It indicates why firms, not agents, own assets, and why peer-dependent incentive systems are more common within than between firms.

Keywords: Relational contracts; multiagent moral hazard; endogenous hold-up

JEL-codes: D23; J33; L14

23 pages, November 30, 2007

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