Contracting with Synergies

40 Pages Posted: 21 Nov 2011

See all articles by Alex Edmans

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

John Zhu

University of Pennsylvania, The Wharton School, Finance Department

Multiple version iconThere are 4 versions of this paper

Date Written: November 2011

Abstract

This paper studies optimal contracting under synergies. We define influence as the extent to which effort by one agent reduces a colleague's marginal cost of effort, and synergy to be the sum of the (unidimensional) influence parameters across a pair of agents. In a two-agent model, effort levels are equal even if influence is asymmetric. The optimal effort level depends only on total synergy and not individual influence parameters. An increase in synergy raises total effort and total pay, consistent with strong equity incentives in small firms, including among low-level employees. The influence parameters matter only for individual pay. Pay is asymmetric, with the more influential agent being paid more, even though the level and productivity of effort are both symmetric. With three agents, effort levels differ and are higher for more synergistic agents. An increase in the synergy between two agents can lead to the third agent being excluded from the team, even if his productivity is unchanged. This has implications for optimal team composition and firm boundaries. Agents that influence a greater number of colleagues receive higher wages, consistent with the salary differential between CEOs and divisional managers.

Suggested Citation

Edmans, Alex and Goldstein, Itay and Zhu, John, Contracting with Synergies (November 2011). NBER Working Paper No. w17606. Available at SSRN: https://ssrn.com/abstract=1962498

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
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London NW1 4SA
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European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
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Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
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Philadelphia, PA 19104
United States
215-746-0499 (Phone)

John Zhu

University of Pennsylvania, The Wharton School, Finance Department ( email )

3620 Locust Walk
Philadelphia, PA 19104
United States

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