Delegation to Encourage Communication of Problems
36 Pages Posted: 17 Nov 2005
Date Written: November 14, 2005
Abstract
We consider a principal-agent model where the agent is hired to take an action on behalf of the principal. The agent can exert costly effort to learn the true state of the world. If he fails to discover the state, he can end an inquiry to the principal who then can exert (additional) costly effort to learn the state of the world. If the true state is unknown, the principal's preferred action may be different from the agent's. In other words, the principal and the agent have different preferences over Type I and Type II errors. Knowing this, the agent, when uninformed, may decide not to report a problem if the principal is unlikely to select a correct action. The principal, in anticipation of the possibility of no inquiry, can provide an incentive for the agent to send an inquiry by allowing the agent to ignore the principal's recommendation. We label this organizational arrangement delegation. Alternatively, the principal can choose centralization - an arrangement where the principal's recommendation, if issued, is always binding. We demonstrate that the principal may choose centralization for two reasons: (i) to exercise better control over the agent's actions when the agent finds it optimal to send an inquiry, and (ii) to dissuade the agent from sending an inquiry altogether when, by doing so, she provides a stronger incentive for the agent to exert high effort. Delegation emerges in equilibrium only if the costs of effort for both the principal and the agent are sufficiently high and occurs less often as the principal's and agent's preferences become better aligned. Further, the agent's information acquisition effort under delegation is always lower than under centralization.
Keywords: delegation, communication
JEL Classification: D82, L20, M40, M46
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Recommended Papers
-
Balanced Budget Rules and Public Deficits: Evidence from the U.S. States
By Henning Bohn and Robert P. Inman
-
Capital Budgeting and Delegation
By Milton Harris and Artur Raviv
-
Capital Budgeting and Compensation with Asymmetric Information and Moral Hazard
By Antonio E. Bernardo, Hongbin Cai, ...
-
Budget Referendums and Government Spending: Evidence from Swiss Cantons
By Lars P. Feld and John G. Matsusaka
-
Decision Processes, Agency Problems, and Information: An Economic Analysis of Budget Procedures
-
Decision Processes, Agency Problems, and Information: An Economic Analysis of Budget Procedures
-
Economic Incentives and Political Institutions: Spending and Voting in School Budget Agenda
By Thomas Romer, Howard Rosenthal, ...
-
Allocation of Decision-Making Authority
By Milton Harris and Artur Raviv
-
Why the NPV Criterion Does Not Maximize NPV
By Elazar Berkovitch and Ronen Israel
-
By Ricardo Alonso and Niko Matouschek