Managing Authority and Incentives in Relational Contracts

Abstract

We consider a relational contracting model in which the parties choose to allocate authority either to the principal (centralization) or to the agent (delegation). The party who has authority chooses a project, and the agent exerts effort to successfully execute the project. Delegation generates (i) a positive effect to motivate the agent to exert effort through credible choice of the agent's favoured project; and (ii) a negative effect that induces an inefficient project to avoid the agent's deviation to his favourite project. Consequently, delegation is inclined to be optimal for the parties with low discount factors.