Abstract
In this paper, we introduce the notion of transferable control, defined as a situation where one party (the principal, say) can transfer control to another party (the agent) but cannot commit herself to do so. One theoretical foundation for this notion builds on the distinction between formal and real authority introduced by Aghion and Tirole, in which the actual exercise of authority may require noncontractible information, absent which formal control rights are vacuous. We use this notion to study the extent to which control transfers may allow an agent to reveal information regarding his ability or willingness to cooperate with the principal in the future. We show that the distinction between contractible and transferable control can drastically influence how learning takes place: with contractible control, information about the agent can often be acquired through revelation mechanisms that involve communication and message-contingent control allocations; in contrast, when control is transferable but not contractible, it can be optimal to transfer control unconditionally and learn instead from the way in which the agent exercises control.
Highlights
Much progress has been accomplished in the last fifteen years in modelling control allocation and in using this notion to analyze vertical and lateral integration,1 financing decisions,2 and the allocation of authority within firms
One theoretical foundation for this notion of transferable control builds on the distinction between formal and real authority introduced by Aghion and Tirole (1997), in which the actual exercise of authority may require certain critical information, absent which formal control rights are vacuous4; and while formal control rights could be contracted upon, information transfers may not
Aghion et al Transferable Control and transferable control can drastically influence how learning takes place: with contractible control, information about the agent can often be acquired through revelation mechanisms that involve communication and message-contingent control allocations; in contrast, when control is transferable but not contractible, it can be optimal to transfer control unconditionally and learn instead from the way in which the agent exercises this control
Summary
This section outlines an incomplete information framework where control allocation serves as a natural instrument to enhance trust and cooperation. A good A is willing to cooperate in Stage 1 and gains g from P’s implementing the project; in contrast, a bad A gains B from the noncooperative design action N; he gains b from the implementation of the project, but prefers the noncooperative design action N even if this induces P to stop the project (B Ͼ b). P incurs a loss l from the noncooperative action at the design stage and an even bigger loss L from implementing the project when the agent has a bad type; P is willing to let a bad A choose the noncooperative action at the design stage to learn his type (and stop the project) This payoff structure is that of a typical signalling game, where preference heterogeneity between the two types of A can allow for separation. When parties are instead responsive to monetary incentives (in Section 5), optimal contracts include message-contingent transfer payments
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