Limited Communication and Responsibility Budgeting

Abstract

We consider an agency model with three-tier hierarchy, in which the principal cannot observe the manager's and the worker's task environments. Communication is limited in that only the manager can report to the principal about the task environments. The principal decides whether or not to give the manager responsibility for project budgeting. Under responsibility budgeting, the manager receives all of the resources for the project tasks and shares those resources with the worker. Although the manager in such an arrangement has more direct sources of information rent, his rent-seeking incentive becomes weaker. This trade-off determines whether or not larger responsibility for budgeting is optimal.