Budgeting and Hierarchical Control
Posted: 12 Jun 1997
Date Written: Undated
This paper studies incentives in hierarchical organizations. Benchmark performance is given by the optimal revelation mechanism in which the principal communicates and contracts directly with all agents. We analyze under what conditions a general multi-tier hierarchy can replicate the performance of the optimal revelation mechanism. We find that replication is possible if the hierarchical arrangement of the agents is consistent with the underlying production structure, and the organization sets up a suitable internal accounting system. Specifically, each department manager is given a budget by his superior for a specific departmental task. Performance is then measured by the difference between the budget and actual cost incurred by the department.
JEL Classification: D82, L23, M40, M46
Suggested Citation: Suggested Citation