Moral Hazard, Hold-Up, and the Optimal Allocation of Control Rights

Abstract

I examine the optimal allocation of control rights in a model with manager moral hazard, where the manager and investor may hold-up each other ex post. The control allocation determines both the likelihood of hold-up and the agents' renegotiation payoffs. In equilibrium, only two control allocations are optimal: either exclusive investor control or a contingent control allocation that allows the manager to remain in control if, and only if, interim performance is good. Thus, my model explains why it may be optimal to link control to the firm's performance such that managers retain control only following good performance.

Keywords: Control rights, Contingent control, Hold-up problem, Moral hazard

JEL Classification: G30, G32, G24