Profit Centers and Incentives in Teams

42 Pages Posted: 9 Jun 2001

See all articles by Anthony M. Marino

Anthony M. Marino

University of Southern California - Marshall School of Business

Jan Zabojnik

Queen's University - Department of Economics

Date Written: May 15, 2001

Abstract

Standard models of team production imply that, due to the free rider problem, profit sharing tends to have negligible incentive effects in large organizations. Many observers therefore find the use of profit sharing in large firms puzzling. In this paper we show that if a firm can be decomposed into two separate teams whose outputs can be observed, then a tournament between these two teams sometimes solves the free rider problem. Moreover, we show that the relationship between production risk and the strength of incentives in an optimal tournament contract can be positive, contrary to the standard conclusion that optimal contracts should exhibit a trade-off between risk and uncertainty. We use our efficiency results to endogenize the firm's organizational structure. In particular, we show that in the presence of economies of scale, small firms tend to be organized as unitary firms, while large firms will tend to choose the multidivisional organizational form.

Keywords: Profit Centers, Team Tournaments

JEL Classification: L2, L1, J3, D2

Suggested Citation

Marino, Anthony M. and Zabojnik, Jan, Profit Centers and Incentives in Teams (May 15, 2001). USC CLEO Research Paper No. C01-22; and USC Finance & Business Econ. Working Paper No. 01-17. Available at SSRN: https://ssrn.com/abstract=272609 or http://dx.doi.org/10.2139/ssrn.272609

Anthony M. Marino (Contact Author)

University of Southern California - Marshall School of Business ( email )

Dept. of Finance & Business Economics
Los Angeles, CA 90089
United States
213-740-6525 (Phone)
213-740-6650 (Fax)

Jan Zabojnik

Queen's University - Department of Economics ( email )

94 University Avenue
Kingston, Ontario K7L 3N6
Canada
613-533-2275 (Phone)
613-533-6668 (Fax)

HOME PAGE: http://qed.econ.queensu.ca/faculty/zabojnik/Page/

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