Contracting with Synergies

51 Pages Posted: 17 Jul 2013

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: July 2013

Abstract

This paper studies multi-agent optimal contracting with cost synergies. We model synergies as the extent to which effort by one agent reduces his colleague's marginal cost of effort. An agent's pay and effort depend on the synergies he exerts, the synergies his colleagues exert on him and, surprisingly, the synergies his colleagues exert on each other. It may be optimal to "over-work" and "over-incentivize" a synergistic agent, due to the spillover effect on his colleagues. This result can rationalize the high pay differential between CEOs and divisional managers. An increase in the synergy between two particular agents can lead to a third agent being endogenously excluded from the team, even if his own synergy is unchanged. This result has implications for optimal team composition and firm boundaries.

Keywords: complementarities, contract theory, influence, multiple agents, principal-agent problem, synergies, teams

JEL Classification: D86, J31, J33

Suggested Citation

Edmans, Alex and Goldstein, Itay and Zhu, John, Contracting with Synergies (July 2013). CEPR Discussion Paper No. DP9559. Available at SSRN: https://ssrn.com/abstract=2294818

Alex Edmans (Contact Author)

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

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
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
3620 Locust Walk
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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