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Optimal contracting and the organization of knowledge

Fuchs, William, Garicano, Luis and Rayo, Luis (2014) Optimal contracting and the organization of knowledge. CEP Discussion Papers (CEPDP1308). Centre for Economic Performance, London School of Economics and Political Science, London, UK.

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Abstract

We study contractual arrangements that support an efficient use of time in a knowledge-intensive economy in which agents endogenously specialize in either production or consulting. The resulting market for advice is plagued by informational problems, since both the difficulty of the questions posed to consultants and the knowledge of those consultants are hard to assess. We show that spot contracting is not efficient since lemons (in this case, self-employed producers with intermediate knowledge) cannot be appropriately excluded from the market. However, an ex-ante, firm-like contractual arrangement uniquely delivers the first best. This arrangement involves hierarchies in which consultants are full residual claimants of output and compensate producers via incentive contracts. This simple characterization of the optimal ex-ante arrangement suggests a rationale for the organization of firms and the structure of compensation in knowledge-intensive sectors. Our findings correspond empirically to observed arrangements inside professional service firms and between venture capitalists and entrepreneurs.

Item Type: Monograph (Discussion Paper)
Official URL: http://cep.lse.ac.uk/_new/publications/series.asp?...
Additional Information: © 2014 The Authors
Divisions: Economics
Management
Centre for Economic Performance
Subjects: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HD Industries. Land use. Labor
H Social Sciences > HD Industries. Land use. Labor > HD28 Management. Industrial Management
JEL classification: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D86 - Economics of Contract: Theory
J - Labor and Demographic Economics > J3 - Wages, Compensation, and Labor Costs > J33 - Compensation Packages; Payment Methods
J - Labor and Demographic Economics > J4 - Particular Labor Markets > J44 - Professional Labor Markets and Occupations
L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior > L22 - Firm Organization and Market Structure: Markets vs. Hierarchies; Vertical Integration; Conglomerates; Subsidiaries
Sets: Departments > Economics
Departments > Management
Research centres and groups > Centre for Economic Performance (CEP)
Date Deposited: 17 Dec 2014 10:00
Last Modified: 20 Feb 2019 03:49
Funders: Economic and Social Research Council
URI: http://eprints.lse.ac.uk/id/eprint/60531

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