Technological Improvement and the Decentralizatiton Penalty in a Simple Principal/Agent Model

Abstract

We consider the organizer of a firm who compares a decentralized arrangement where divisions are granted total autonomy with an arrangement where perfect monitoring and policing guarantee that all divisions make the choices the organizer wants them to make. We ask: when does improvement in the divisions' technology strengthen the case for decentralization and when does it weaken it? We study this question, for the case of a single division, in a complete-information linear-contract setup. It turns out that there are no simple conditions under which the welfare loss due to decentralization grows (shrinks) when technology improves. Instead, we obtain a variety of results about relations between technology, surplus, the Principal's generosity (i.e. the Principal's optimal share of the contract), and effectiveness (the effect of a small rise in the share on the Agent's effort).