Technical Change, Moral Hazard, and the Decentralization Penalty

39 Pages Posted: 27 Jul 2020 Last revised: 11 Mar 2024

See all articles by Thomas Marschak

Thomas Marschak

University of California, Berkeley - Haas School of Business

Dong Wei

University of California, Santa Cruz - Department of Economics

Date Written: January 10, 2023

Abstract

We consider two modes of organizing a firm and we compare them with regard to
social welfare. In the Centralized mode, worker-control techniques, together with adequate compensation, insure that the worker chooses a welfare-maximizing effort. In the Decentralized mode the worker is not controlled. Instead a profit-driven Principal contracts with a self-interested Agent (worker) who freely chooses an effort and bears its cost. The Principal rewards the Agent once she sees the revenue generated by the Agent's hidden choice. The loss of surplus when the Principal induces her favorite effort is called the Decentralization Penalty. For certain common contract types, we study the behavior of the Penalty in response to changes in production technology. We find that as production technology improves, the Penalty oscillates. It follows a continuous-rise-sudden-change cycle. Under reasonable assumptions on costs and expected revenues, the sudden change must be a drop. While advances in worker-control technology always strengthen the social-welfare case for the Centralized mode, advances in production technology may do the opposite.

Suggested Citation

Marschak, Thomas and Wei, Dong, Technical Change, Moral Hazard, and the Decentralization Penalty (January 10, 2023). Available at SSRN: https://ssrn.com/abstract=3659638 or http://dx.doi.org/10.2139/ssrn.3659638

Thomas Marschak (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

Dong Wei

University of California, Santa Cruz - Department of Economics ( email )

Santa Cruz, CA 95064
United States

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