Incomplete Contract and Divisional Structures

Research, Preprint OPEN
Te Bao ; Yongqin Wang (2009)
  • Publisher: Tinbergen Institute Amsterdam and Rotterdam
  • Subject: D23 | incomplete contract | bargaining | Verhalten in Organisationen | L22 | Unvollständiger Vertrag | Verhandlungstheorie | Unternehmensorganisation | Organisationsstruktur | organizational form, divisional structure, incomplete contract, bargaining | organizational form | divisional structure | Theorie
    • jel: jel:D23 | jel:L22
      ddc: ddc:330

In this paper we want to analyze the internal divisional structure within an organi- zation in the framework of incomplete contract theory. We use the framework of Aghion and Tirole (1997) and define the managerial control structure as \sequence of search". A key feature of this paper which differentiate it from other works in the literature is that we add add an ex post bargaining phase in which the managers can agree on the project which maximize their joint private benefit. Our model shows the share of co- operative surplus the managers can get from bargaining and their default pay off plays a key role in determining their search effort. When there is no spill over effect between the agents' effort, internal separation is always dominated by internal integration with control right assigned to the agent (manager) with high interest congruence with the principal (head quarter). When there are synergy effect and setup cost during integra- tion, the principal need to consider the cost-benefit trade off as Riyanto (2000) suggests. But more importantly, the optimal divisional structure depends heavily on whether the bargaining is interest congruence enhancing (increase the interest congruence between agents and the principal) or destroying (decrease the interest congruence). JEL Classification: D23, L22 Key words: organizational form, divisional structure, incomplete contract, bargaining
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