Resource Allocation Auctions within Firms

32 Pages Posted: 11 Dec 2007

See all articles by Stanley Baiman

Stanley Baiman

University of Pennsylvania - Accounting Department

Madhav V. Rajan

Booth School of Business, University of Chicago

Richard E. Saouma

Eli Broad College of Business, Michigan State University

Date Written: 2007-04-17

Abstract

There is growing interest in the use of markets within firms. Proponents have noted that markets are a simple and efficient mechanism for allocating resources in economies in which information is dispersed. In contrast to the use of markets in the broader economy, the efficiency of an internal market is determined in large part by the endogenous contractual incentives provided to the participating, privately informed agents. In this paper, we study the optimal design of managerial incentives when resources are allocated by an internal auction market, as well as the efficiency of the resulting resource allocations. We show that the internal auction market can achieve first-best resource allocations and decisions, but only at an excessive cost in compensation payments. We then identify conditions under which the internal auction market and associated optimal incentive contracts achieve the benchmark second-best outcome as determined using a direct revelation mechanism. The advantage of the auction is that it is easier to implement than the direct revelation mechanism. When the internal auction mechanism is unable to achieve second-best, we characterize the factors that determine the magnitude of the shortfall. Overall, our results speak to the robust performance of relatively simple market mechanisms and associated incentive systems in resolving resource allocation problems within firms.

Suggested Citation

Baiman, Stanley and Rajan, Madhav V. and Saouma, Richard E., Resource Allocation Auctions within Firms (2007-04-17). Journal of Accounting Research, Vol. 45, Issue 5, pp. 915-946, December 2007. Available at SSRN: https://ssrn.com/abstract=1065888 or http://dx.doi.org/10.1111/j.1475-679X.2007.00255.x

Stanley Baiman (Contact Author)

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-6782 (Phone)
215-573-2054 (Fax)

Madhav V. Rajan

Booth School of Business, University of Chicago

1101 East 58th Street
Chicago, IL 60637-1561
United States

Richard E. Saouma

Eli Broad College of Business, Michigan State University ( email )

Agriculture Hall
East Lansing, MI 48824-1122
United States

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