Abstract
This article gives a new explanation for the phenomenon of subcontracting. A model in which a principal contracts two agents who work in a sequence on a project, have soft information and can collude is considered. Side-contracts between agents can be signed at any stage of the game. It is shown that in this setting both a decentralized contracting structure, in which contracting of the agents at the initial production stage is delegated to the agent at the final production stage, and a centralized structure, in which the principal directly contracts both agents, can be superior for the principal. The article derives the conditions under which this holds. The results give an explanation for recently observed tendencies in public procurement of design and construction activities.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
References
Baliga S., Sjöström T. (1998) Decentralization and collusion. Journal of Economic Theory 83: 196–232
Baron D. P., Besanko D. (1992) Information, control, and organizational structure. Journal of Economics and Management Strategy 1: 237–275
Celik G. (1999) Mechanism design with collusive supervision. Journal of Economic Theory 144: 69–95
Che Y.-K., Yoo S.-W. (2001) Optimal incentives for teams. American Economic Review 91: 525–541
Dimitri N., Piga G., Spagnolo G. (2006) Handbook of procurement. Cambridge University Press, Cambridge
FAR. (2005). Federal Acquisition Regulation. http://www.arnet.gov/far/current/pdf/FAR.book.pdf.
Faure-Grimaud A., Martimort D. (2001) On some agency costs of intermediated contracting. Economics Letters 71(1): 75–82
Faure-Grimaud A., Laffont J.-J., Martimort D. (2003) Collusion, delegation and supervision with soft information. Review of Economic Studies 70: 253–279
Holmström B., Milgrom P. (1990) Regulating trade among agents. Journal of Institutional and Theoretical Economics 146: 85–105
Itoh H. (1993) Coalitions, incentives, and risk sharing. Journal of Economic Theory 60: 410–427
Jelovac I., Macho–Stadler I. (2002) Comparing organizational structures in health services. Journal of Economic Behavior & Organization 49: 501–522
Laffont J. J., Martimort D. (1998) Collusion and delegation. Rand Journal of Economics 29: 280–305
Laffont J. J., Martimort D. (2002) The theory of incentives. Princeton University Press, Princeton
Lam E., Chan A., Chan D. (2006) Barriers to applying the design-build procurement method in Hong Kong. Architectural Science Review 49(2): 189–195
Macho-Stadler I., Pérez-Castrillo D. (1998) Centralized and decentralized contracts in a moral hazard environment. Journal of Industrial Economics 66: 489–510
McAfee R. P., McMillan J. (1995) Organizational diseconomies of scale. Journal of Economics and Management Strategy 4(3): 399–426
Melumad N., Mookherjee D., Reichelstein S. (1995) Hierarchical decentralization of incentive contracts. Rand Journal of Economics 26: 654–672
Melumad N., Mookherjee D., Reichelstein S. (1997) Contract complexity, incentives, and the value of delegation. Journal of Economics and Management Strategy 6(2): 257–289
Mookherjee D. (2006) Decentralization, hierarchies and incentives: a mechanism design perspective. Journal of Economic Literature 64: 367–390
Myerson R.B. (1982) Optimal coordination mechanisms in general principal–agent problems. Journal of Mathematical Economics 10: 67–81
Poitevin, M. (1995) Contract renegotiation and organizational design. CIRANO Working Paper, pp. 95–93.
Radner R. (1993) The organization of decentralized information processing. Econometrica 61(5): 1109–1146
Schmitz P. (2005) Allocating control in agency problems with limited liability and sequential hidden actions. RAND Journal of Economics 36: 318–336
Shore H., Commander E. (2003) Design-build on government projects. In: Quatman W., Dhar R. (eds) The architect’s guide to design-build services. Wiley, Hoboken, pp 213–230
Theilen, B. (2008) Lobbying and Contract Delegation in Public Procurement. The B.E. Journal of Economic Analysis & Policy, 8(Topics), Article 38.
Theilen, B. (2009), Monitoring gains and decentralization. The B.E. Journal of Theoretical Economics, 9(Topics), Article 32.
Theilen, B. (2011). Contract delegation with bargaining. Economic Inquiry. DOI:10.1111/j.1465-7295.2011.00404.x
Tirole J. (1986) Hierarchies and bureaucracies: on the role of collusion in organizations. Journal of Law, Economics, and Organization 2: 181–214
Tirole J. (1992) Collusion and the theory of organizations. In: Laffont J.J. (eds) Advances in economic theory: Proceedings of the sixth world congress of the econometric society. Cambridge University Press, Cambridge
Tirole J. (1999) Incomplete contracts: Where do we stand?. Econometrica 67: 741–781
van Zandt T. (1996) Decentralized information processing in the theory of organizations. In: Sertel M. (eds) Contemporary economic development reviewed, Vol. 4: The enterprise and its environment. Macmillan Press, London, pp 125–160
Varian H. (1990) Monitoring agents with other agents. Journal of Institutional and Theoretical Economics 146: 153–174
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Theilen, B. Decentralization of contracts with interim side-contracting. Theory Decis 73, 561–590 (2012). https://doi.org/10.1007/s11238-011-9290-3
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11238-011-9290-3