Managing Authority and Incentives in Relational Contracts

Abstract: We consider a relational contracting model in which the parties choose whether to allocate authority either to the principal (centralization) or to the agent (delegation). The party who has authority chooses a project, and the agent exert effort to successfully execute the project. Under delegation, although the agent’s effort is motivated by his authority, the project selected by the agent may be inefficiently biased toward the agent’s favourite one to deter the agent’s deviation to his most favourite project. Consequently, delegation (centralization) is inclined to be optimal for the parties with low (high) discount factors.