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Optimal contracting and the organization of knowledge

Fuchs, William and Garicano, Luis and Rayo, Luis (2015) Optimal contracting and the organization of knowledge. Review of Economic Studies, 82 (2). pp. 632-658. ISSN 0034-6527

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Identification Number: 10.1093/restud/rdu043

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 because 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: Article
Official URL: https://academic.oup.com/restud
Additional Information: © 2014 The Authors
Divisions: Economics
Management
Centre for Economic Performance
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HD Industries. Land use. Labor
JEL classification: D - Microeconomics > D2 - Production and Organizations > D20 - General
D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information
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 > J41 - Contracts: Specific Human Capital, Matching Models, Efficiency Wage Models, and Internal Labor Markets
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: 30 May 2017 14:27
Last Modified: 02 Nov 2017 15:07
URI: http://eprints.lse.ac.uk/id/eprint/79240

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