Optimal Delegated Contracting

Abstract

We investigate a setting where two agents exert complementary efforts on a principal’s project. In standard Principal-Agent theory, contracts are public and it is at least weakly better for a principal to contract directly with each agent. Yet in the real world, delegated contracting is very common. We show delegated contracting can be optimal when that the terms of incentive contracts are observed only by the direct signatories to those contracts. With centralized contracting, each agent fears that the principal will opportunistically reduce the other agents bonus, muting incentives to exert effort. With delegated contracting, one agent observes the contract of the agent he hires, alleviating effort concerns, but allowing rent extraction. In delegating, the principal trades off the loss of control and rent extraction by the hiring agent against the gains from improved observability and effort.

Keywords: delegation, private contracts, moral hazard, subcontracting, complementarities

JEL Classification: D86, G34, G23, G24