The Assignment of Decision Rights in Formal Information Systems

Abstract:     
Contracting theory assumes a verifiable report on which to base required payments. We demonstrate the importance of decision rights for this central feature of the theory by examining the optimal assignment of the right to decide the interpretations required by the reporting process. Admissible interpretations emanate primarily from prototypical cases, and multiple interpretations may be admissible when non-prototypical cases arise, leading to a "diversity of positions." We identify conditions where a principal would strictly prefer to assign these rights to his agent. What is surprising about the result is that neither individual has a natural advantage in making the choice, and the assignment of rights alleviates problems jointly caused by the inability to contract on qualitative factors, agent risk aversion, and an information system that detects shirking better than working. We also identify conditions for which the principal welcomes an increased diversity of positions and note connections to principles-based reporting.

Number of Pages in PDF File: 32

Keywords: Decision rights, Formal information, Incomplete contracts

JEL Classification: D23, D73, D82, M40, M41, M46

working papers series