Private Compensation and Organizational Design

Abstract

Most real world compensation contracts are private information, observed only by their direct signatories. This matters when agents work together to produce a joint output, because they care about each others’ incentives. Then, the principal can gain from designating one agent "team leader," with authority to decide all the bonuses. Such "outsourcing" of contracting, never optimal with fully public contracts, raises effort by improving observability, reassuring agents that the incentives provided are sufficiently strong; but distorts effort allocation, as the team leader is excessively compensated. Holding observability constant, delegation can raise output by skewing bonus pay towards more productive agents.

Keywords: privacy, private contracts, pay transparency, delegation, moral hazard, team, outsourcing, complementarities

JEL Classification: D86, D23