Moral Hazard, Hold-Up, and the Optimal Allocation of Control Rights

47 Pages Posted: 15 Mar 2006 Last revised: 25 Sep 2012

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business

Date Written: August 31, 2011

Abstract

I examine the optimal allocation of control rights in a model with manager moral hazard, where the manager and investor may hold-up each other ex post. The control allocation determines both the likelihood of hold-up and the agents' renegotiation payoff s. In equilibrium, only two control allocations are optimal: either exclusive investor control or a contingent control allocation that allows the manager to remain in control if, and only if, interim performance is good. Thus, my model explains why it may be optimal to link control to the firm's performance such that managers retain control only following good performance.

Keywords: Control rights, Contingent control, Hold-up problem, Moral hazard

JEL Classification: G30, G32, G24

Suggested Citation

Yerramilli, Vijay, Moral Hazard, Hold-Up, and the Optimal Allocation of Control Rights (August 31, 2011). RAND Journal of Economics, Vol. 42, No. 4, 2011. Available at SSRN: https://ssrn.com/abstract=890865 or http://dx.doi.org/10.2139/ssrn.890865

Vijay Yerramilli (Contact Author)

University of Houston, C. T. Bauer College of Business ( email )

Houston, TX 77204
United States
713-743-2516 (Phone)

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