Managing Authority and Incentives in Relational Contracts

Abstract

We consider a relational contracting model in which the parties choose whether to allocate authority either to the principal (centralization) or to the agent (delegation). The party who has authority chooses a project, and the agent exerts effort to successfully execute the project. Delegation combines the control rights of the project and the effort level and allocates them to the agent, which generates both (i) a positive effect to motivate the agent to exert effort through credible choice of a biased project in favour of the agent; and (ii) a negative effect that induces an inefficient project to avoid the agent's deviation to his favourite project. Consequently, delegation (centralization) is inclined to be optimal for parties with low (high) discount factors.

Keywords: Relational Contracts, Authority, Centralization, Delegation, Project Choice

JEL Classification: D23, D86, L14, M12