Pei, Di (2010): Risk, limited liability and firm scope.
Download (483Kb) | Preview
This paper provides a new explanation for the relationship between firm scope, agent's effort and corporate risk. I set up a moral hazard in teams model with multiple agents and departments under the assumption that both the principal and the agents are protected by limited liability. Each agent exerts effort to reduce the probability of loss of his department. The two-sided limited liability assumption creates an externality between agents, since the bad performance of an agent could reduce the firm’s expected profit, and decrease the expected payoff of a good performing agent within the same firm. This would lower the incentive for other agents to exert effort, which causes 'Contagious shirking'. I prove for the optimal contract and derive conditions for effort to increase or decrease with scope, and explain why ‘contagious effect’ could better answer this question than diversification when firm scope is large.
|Item Type:||MPRA Paper|
|Original Title:||Risk, limited liability and firm scope|
|English Title:||Risk, limited liability and firm scope|
|Keywords:||firm scope, moral hazard in teams, two-sided limited liability|
|Subjects:||D - Microeconomics > D2 - Production and Organizations > D21 - Firm Behavior: Theory|
|Depositing User:||Di Pei|
|Date Deposited:||29. Dec 2010 20:32|
|Last Modified:||19. Feb 2013 01:10|
Aghion, Philippe, Oliver Hart and John Moore, "The Economics of Bankruptcy Reform", Journal of Law, Economics and Organization, (1992) Vol.8, 523-546
Aghion, Philippe, and Jean Tirole, "Formal and Real Authority in Organizations," Journal of Political Economy, (1997), Vol.105, Issue 1, 1-27.
Biais Bruno, Thomas Mariotti, Jean-Charles Rochet, and Stephane Villeneuve, "Large Risks, Limited Liability and Dynamic Moral Hazard" Econometrica (2010) Vol. 78, Issue 1, 73-118
Coase, Ronald, "The Nature of the Firm," Economica, (1937), Vol.9, 386-405.
Che, Yeon-Koo, and Donald B. Hausch, "Cooperative Investments and the Value of Contracting," American Economic Review, (1999) Vol. 89, 125-147.
Chung, Kai-Lai, "A Course in Probability" (Academic Press 1968)
Fischer Paul, and Steven Huddart, "Optimal Contracting with Endogenous Social Norms" American Economic Review (2008) Vol.98, Issue 4, 1459-1475
Gibbons, Robert, "Four Formal(izable) Theories of the Firm", Journal of Economic Behavior & Organization (2005) Vol.58, 200-245
Gneezy, Uri and Aldo Rustichini, "Pay Enough or Don't Pay at All" Quarterly Journal of Economics, (2000) Vol.115, Issue 3, 791-810
Grossman, Sanford, and Oliver Hart, "The Costs and the Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, (1986) Vol.94 ,691-719.
Halpern, Paul, Michael Trebilcock and Stuart Turnbull, "An Economic Analysis of Limited Liability in Corporation Law", The University of Toronto Law Journal, (1980) Vol. 30, No. 2, pp. 117-150
Hart, Oliver, Firms, Contracts, and Financial Structure (Oxford: Clarendon Press, 1995)
Hart, Oliver, and Bengt Holmström, "A Theory of Firm Scope" Quarterly Journal of Economics, (2010) Vol.125 Issue 2, 483-513
Hart, Oliver, and John Moore, "Property Rights and the Nature of the Firm," Journal of Political Economy, (1990) Vol.98, 1119-1158
Hiriart, Yolande and David Martimort, "The Benefits of Extended Liability", The RAND Journal of Economics, (2006) Vol.37, Issue 3, 562-582
Holmström, Bengt, "Moral Hazard and Observability," Bell Journal of Economics, (1979) Vol.5, 74-91
Holmström, Bengt, "Moral Hazard in Teams," Bell Journal of Economics, (1982) Vol.8, 324-340
Laux, Christian, "Limited Liability and Incentive Contracting with Multiple Projects" RAND Journal of Economics (2001) Vol. 32, No. 3, 514-526
Lewis T.R. "Bonuses and Penalties in Incentive Contracting" Bell Journal of Economics, (1980) Vol. 6, 292-301
Klein, Benjamin, Robert Crawford, and Armen Alchian, "Vertical Integration, Appropriable Rents and the Competitive Contracting Process," Journal of Law and Economics, (1978), Vol.11, 297-326
Najjar, Nabil, "Incentive Contracts in Two-Sided Moral Hazards with Multiple Agents" Journal of Economic Theory (1997) Vol.74, Issue 1, Pages 174-195
Qian, Yingyi. "Incentives and Loss of Control in an Optimal Hierarchy." Review of Economic Studies (1994) Vol.61, 527-544
Rasmusen, Eric, "Moral Hazard in Risk Averse Teams", The RAND Journal of Economics, (1987) Vol.18, Issue 3, 428-435
Rayo, Luis, "Relational Incentives and Moral Hazard in Teams" Review of Economic Studies, (2007) Vol. 74, Issue 3, 937-963
Williamson, Oliver, "The Economic Institutions of Capitalism". (Free Press 1985)