Economic Theory

, Volume 63, Issue 3, pp 587–619 | Cite as

Observability and endogenous organizations

  • Weerachart T. Kilenthong
  • Gabriel A. Madeira
Research Article


This paper establishes a relationship between the observability of common shocks and optimal organizational design in a multiagent moral hazard environment. We consider two types of organizations, namely relative performance and cooperative regimes, and show that, with sufficient information regarding common shocks, a cooperative organization can be optimal even if outputs are highly correlated. The model is then embedded in a Walrasian general equilibrium model in which choices regarding organizations and investment in information on common shocks are jointly determined. Numerical results reveal that both cooperative and relative performance regimes can coexist in equilibrium but only cooperative organizations invest in full observability of common shocks. Changes in the cost of information and aggregate wealth can affect substantially the types of organizations operating and the matching patterns of heterogeneous agents in these organizations. General equilibrium effects are key in determining how information costs impact the way production is organized.


Organizational design Observability Relative performance regime Group regime General equilibrium Value of information 

JEL Classification

D23 D71 D85 O17 



We are thankful for helpful comments by Fernanda Estevan, Rafael Costa Lima, Ricardo Cavalcanti, Marcos Nakaguma, Ned Prescott, Robert Townsend, the associate editor, two anonymous referees and participants at LAMES (Buenos Aires, 2009), SAET (Paris, 2013), and academic seminars at FEA-USP, FEARP-USP, PUC-RJ, FGV-RJ, FGV-SP. Tee Kilenthong would like to thank the University of the Thai Chamber of Commerce for the financial support. Gabriel Madeira gratefully acknowledges financial support from Fipe.


  1. Ahlin, C., Townsend, R.: Selection into and across credit contracts: theory and field research. J. Econom. 136(2), 665–698 (2007)CrossRefGoogle Scholar
  2. Barlevy, G., Neal, D.: Pay for percentile. Am. Econ. Rev. 102(5), 1805–1831 (2012)CrossRefGoogle Scholar
  3. Chiappori, P.-A., Samphantharak, K., Schulhofer-Wohl, S., Townsend, R.M.: Heterogeneity and risk sharing in village economies. Quant. Econ. 5, 1–27 (2014)CrossRefGoogle Scholar
  4. Deaton, A.: Saving and income smoothing in cote d’ivoire. J. Afr. Econ. 1(1), 1–24 (1992)CrossRefGoogle Scholar
  5. Fafchamps, M., Gubert, F.: The formation of risk sharing networks. J. Dev. Econ. 83(2), 326–350 (2007)CrossRefGoogle Scholar
  6. Genicot, G., Ray, D.: Group formation in risk-sharing arrangements. Rev. Econ. Stud. 70(1), 87–113 (2003)CrossRefGoogle Scholar
  7. Ghatak, M., Guinnane, T.: The economics of lending with joint liability theory and practice. J. Dev. Econ. 60(1), 195–228 (1999)CrossRefGoogle Scholar
  8. Goldstein, M.: Chop Time, No Friends: Risk and Intrahousehold Insurance in Southern Ghana. Manuscript, London School of Economics, London (2000)Google Scholar
  9. Grimard, F.: Household consumption smoothing through ethnic ties: evidence from Cote dIvoire. J. Dev. Econ. 53(2), 391–422 (1997)CrossRefGoogle Scholar
  10. Holmstrom, B.: Moral hazard and observability. Bell J. Econ. 10(1), 74–91 (1979)CrossRefGoogle Scholar
  11. Holmstrom, B., Milgrom, P.: Regulating trade among agents. J. Inst. Theor. Econ. JITE 146, 85–105 (1990)Google Scholar
  12. Itoh, H.: Coalitions, incentives, and risk sharing. J. Econ. Theory 60(2), 410–427 (1993)CrossRefGoogle Scholar
  13. Jalan, J., Ravallion, M.: Are the poor less well insured? evidence on vulnerability to income risk in rural China. J. Dev. Econ. 58(1), 61–81 (1999)CrossRefGoogle Scholar
  14. Kilenthong, W.T., Madeira, G.A.: Observability and Endogenous Organizations. RIPED Working Paper (2013)Google Scholar
  15. Lazear, E., Rosen, S.: Rank-order tournaments as optimum labor contracts. J. Polit. Econ. 89(5), 841–864 (1981)CrossRefGoogle Scholar
  16. Lazear, E., Shaw, K.: Personnel economics: the economist’s view of human resources. J. Econ. Perspect. 21(4), 91–114 (2007)CrossRefGoogle Scholar
  17. Madeira, G., Townsend, R.: Endogenous groups and dynamic selection in mechanism design. J. Econ. Theory 142(1), 259–293 (2008)CrossRefGoogle Scholar
  18. Mueller, R., Prescott, E., Sumner, D.: Hired hooves: transactions in a south Indian village factor market. Aust. J. Agricult. Resour. Econ. 46, 233–255 (2002)CrossRefGoogle Scholar
  19. Prescott, E., Townsend, R.: General competitive analysis in an economy with private information. Int. Econ. Rev. 25(1), 1–20 (1984)CrossRefGoogle Scholar
  20. Prescott, E., Townsend, R.: Collective organizations versus relative performance contracts: inequality, risk sharing, and moral hazard. J. Econ. Theory 103(2), 282–310 (2002)CrossRefGoogle Scholar
  21. Prescott, E., Townsend, R.: Firms as clubs in Walrasian markets with private information. J. Polit. Econ. 114(4), 644–671 (2006)CrossRefGoogle Scholar
  22. Ramakrishnan, R., Thakor, A.: Cooperation versus competition in agency. J. Law Econ. Organ. 7(2), 248–283 (1991)Google Scholar
  23. Ray, D.: A Game-Theoretic Perspective on Coalition Formation. Oxford University Press, Oxford (2007)CrossRefGoogle Scholar
  24. Townsend, R.: Risk and insurance in village india. Econom. J. Econom. Soc. 62(3), 539–591 (1994)Google Scholar
  25. Townsend, R., Mueller, R.: Mechanism design and village economies: from credit to tenancy to cropping groups. Rev. Econ. Dyn. 1(1), 119–172 (1998)CrossRefGoogle Scholar

Copyright information

© Springer-Verlag Berlin Heidelberg 2016

Authors and Affiliations

  1. 1.University of the Thai Chamber of CommerceBangkokThailand
  2. 2.Universidade de São PauloSão PauloBrazil

Personalised recommendations