An Examination of the Efficiency of Resource Allocation Auctions within Firms

Abstract

Markets have a remarkable capacity for producing efficient resource allocations when information about relative values is dispersed across economic agents. We explore the use of market mechanisms inside the firm to address a resource allocation problem, and compare the outcome with the first- and second-best solution. Although the market mechanism does not always attain the first-best or even second-best benchmark, it is significantly simpler to implement. Moreover, we identify circumstances under which the losses involved in using a market rather than the optimal second-best contract are negligible.

Keywords: capital budgeting, resource allocation, auctions, simple mechanisms, simple contracts, adverse selection, moral hazard

JEL Classification: J41, D82, M40, M46, L22