Abstract
We discuss the internal organization of the firm, arguing that the comparison between a centralized and a decentralized hierarchical organization should be cast in terms of the agency costs associated with the different side-contracting games that agents play in these organizations. In our model, with no limits on communication between the agents and the principal (complete contracting), collusion is not an issue in a centralized organization. Centralization always dominates (at least weakly) delegation. With limits on communication (incomplete contracting), collusion may have some bite under centralization. Limits on communication introduce an anonymity condition on the contract, creating a conflict between participation and coalition incentive constraints under centralization. By shifting the bargaining power in the side-contracting stage, delegation is nonanonymous and asymmetric by design. This conflict is then avoided or diminished depending on the exact timing of the delegation game.
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