Contracting With Synergies

Contracting With Synergies

Alex Edmans, Itay Goldstein, John Zhu

Series number :

Serial Number: 
320/2011

Date posted :

November 01 2011

Last revised :

November 23 2011
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Keywords

  • contract theory • 
  • complementarities • 
  • principal-agent problem • 
  • multiple agents • 
  • teams • 
  • synergies • 
  • influence

This paper studies multi-agent optimal contracting with cost synergies. We model synergies as the extent to which effort by one agent reduces his colleague's marginal cost of effort. An agent's pay and effort depend on the synergies he exerts, the synergies his colleagues exert on him and, surprisingly, the synergies his colleagues exert on each other.

It may be optimal to "over-work" and "over-incentivize" a synergistic agent, due to the spillover effect on his colleagues. This result can rationalize the high pay differential between CEOs and divisional managers. An increase in the synergy between two particular agents can lead to a third agent being endogenously excluded from the team, even if his own synergy is unchanged. This result has implications for optimal team composition and firm boundaries.

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Authors

Real name: 
Itay Goldstein
Real name: 
John Zhu