IP' ¥w\fm MITLIBRARIES DUPL 'ii '"iMiUMi yiJM.,!!'!§,! 3 9080 02246 2482 m ''•"""'"iiilil --7-l!fnlmTrfmHffHnUTJmFl(: i ill it.fiii,iMi I'll'! mi<;ia'i!;;iim!i!i;i;'ft;ti:iii!'ui!i ;|[:n«it!J(iii.; if' |!i,ilU;;:i(!Mi:ii!i;iii|i|ii'i;i;K:iiiii!;;)iiiifi!;iiriii Digitized by the Internet Archive in 2011 with funding from Boston Library Consortium IVIember Libraries http://www.archive.org/details/organizationaldeOOathe DEWEY Massachusetts Institute of Technology Department of Economics Working Paper Series Organizational Design: Decision Rights and Incentive Contracts Susan Athey, MIT and NBER John Roberts, Stanford University Working Paper 01 -12 Room E52-251 50 Memorial Drive MA Cambridge, 02142 This paper can be downloaded witliout cliarge from tine Social Science Research Network Paper Collection at http://papers.ssrn.com/paper.taf?abstract_id=261 773 Massachusetts Institute of Technology Department of Economics Working Paper Series Organizational Design: Decision Riglits and Incentive Contracts Susan Athey, MIT and NBER John Roberts, Stanford University Working Paper 01 -12 Room E52-251 50 Meimorial Drive MA Cambridge, 02142 This paper can be downloaded witlnout cliarge from the Social Science Research Network Paper Collection at http://papers.ssrn.conn/paper.taf?abstractJd=261773 Organizational Design: Decision Rights and Incentive Contracts Susan Athey and John Roberts'^ Where should decision rights be lodged in organizations? Michael C. Jensen and William H. Meckling (1992) argue that moving a decision away from the inherently best-informed party involves costs in communication and garbling but may lodge it with someone who has better incentives to make good decisions. But generally we expect that incentives are part of the organizational design. Why notjust provide incentives to those with the best information so that they make the right decisions? One reason is that the available incentive instruments must serve multiple purposes and designing them to induce better decisions worsens perfonnance against other organizational objectives. Our experience suggests this is a common situation in actual organizations; The means available to affect one sort of behavior or decision mevitably affect the incentives governing other choices. Then the design of incentive schemes and the allocation of decision rights become interlinked. This paper looks at this idea in the specific context of a principal's problem of inducing agents to provide unobservable effort while also motivating the efficient selection of investments. Each of these problems has been extensively studied in isolation (on inducing effort, see, e.g., Bengt Holmstrom 1979, Holmstrom and Paul Milgrom 1991; on decisions see, e.g., Eugene F. Fama and Jensen 1983, Milgrom and John Roberts 1990a, 1990b, Philippe Aghion and Jean Tirole 1997, Tirole and Matthias Dewatripont 1999). We thus know that motivating effort is done best by rewarding agents on precise measures of their effort, not necessarily on the total value created in the firm. At the same time, it is clear that getting the right investment choices may require that the decision makers' rewards be tied to total value 1