Vertical Relationships with Hidden Interactions

Jaesoo Kim and Dongsoo Shin ()
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Jaesoo Kim: Department of Economics, Indiana University-Purdue University Indianapolis, Indianapolis, IN 46202, USA
Dongsoo Shin: Department of Economics, Leavey School of Business, Santa Clara University, Santa Clara, CA 95053, USA

Games, 2023, vol. 14, issue 6, 1-21

Abstract: In an agency model with adverse selection, we study how hidden interactions between agents affect the optimal contract. The principal employs two agents who learn their task environments through their involvement. The principal cannot observe the task environments. It is important to note that hidden interactions, such as acts of sabotage or help between the agents, have the potential to alter each other’s task environments. Our analysis encompasses two distinct organizational structures: competition and cooperation. Without hidden interactions, the competitive structure is optimal because the cooperative structure only provides the agents with more flexibility to collusively misrepresent their task environments. With hidden interactions, however, the cooperative structure induces the agents to help each other to improve the task environments while removing sabotaging incentives at no cost once collusion is deterred. As a result, the cooperative structure can be optimal in such a case. We discuss the link between production technology and organizational structure, finding that complementarity in production favors cooperative structures.

Keywords: agency; collusion; help; sabotage; organizational structure (search for similar items in EconPapers)
JEL-codes: C C7 C70 C71 C72 C73 (search for similar items in EconPapers)
Date: 2023
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