Incomplete contract, bargaining and optimal divisional structure
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When complete contracting is not possible, allocating control structure becomes the second-best arrangement. This paper analyzes the design of optimal divisional structure within an organization where ex post bargaining between the potential divisional managers is possible. In much the same light as Aghion and Tirole (J Political Econ 105(1):1–29, 1997), we study the control problem in the context of search for projects. Our model shows that when the managers cannot bargain with one another, internal integration is preferred to internal separation. Where bargaining is possible, formal divisional structure defines both the ex post bargaining position of the two managers and their incentive to search ex ante. When the managers tend to arrive at a more favorable project to the principal via bargaining, the general leader of a firm may want to choose separation instead to increase the probability of bargaining, as the symmetrical incentive requires both managers to search and get informed.
KeywordsOrganizational design Divisional structure Incomplete contract Bargaining
JEL ClassificationD23 L22
The authors are grateful to the editor Giacomo Corneo and two anonymous referees for helpful comments. We also thank Gabriele Camera, Chenghu Ma and Dilip Mookherjee and the participants of the Netherlands Network of Economics (NAKE) Annual Meeting 2010, 2009 Fudan-Yale Conference “Institutions and Economic Development”, the Inaugural Conference of Chinese Game Theory and Experimental Economics Association, 2010, 16th World Congress of the International Economic Association (IEA) 2011, and Asian Meeting of Econometric Society 2011, and seminar participants at Tinbergen Institute for stimulating discussions. The financial support from Project 985 of Fudan University, China Social Science Foundation Project (05CJL014), the MOE Project of Key Research Institute of Humanities and Social Sciences at Universities (07JJD790130) and Shanghai Leading Academic Discipline Project (B101) are gratefully acknowledged. The usual caveats apply.
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