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.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 632-658 |
| Number of pages | 27 |
| Journal | Review of Economic Studies |
| Volume | 82 |
| Issue number | 2 |
| DOIs | |
| State | Published - Aug 1 2013 |
Funding
It suffices to show that the monopolist can implement the first best and, simultaneously, obtain all gains from trade (namely, hold all agents to their self-employment pay-offs). Assume that all agents sort into their first-best occupations (we will show that, given the contracts that follow, such choices are indeed[ optimal).] First, let the monopolist offer to purchase the residual claim of all unsolved problems from producers z∈ 0,z1∗ for free while at the same time asking those producers to truthfully reveal their types. As producers have nothing to lose, they agree to both. Secondly, let the monopolist offer consultants a menu of contracts 〈τ0(m),τ1(m),Z∗(m)〉m∈[z2∗,1], where τ0(m) is a fixed payment, τ1(m) is a bonus per problem solved, and Z∗(m) is the producer match enjoyed by a consultant who reports to be of type m. Now set thank seminar participants at the AEA meetings, Berkeley, Boston University, Carlos III, CEMFI, Chicago Booth, MIT, Naples, Frankfurt, University of Washington, Washington University, the Utah WBEC, and the NBER for their comments. Miguel Espinosa provided valuable research assistance. L.G. would like to thank the Toulouse Network in Information Technology for financial support. A previous version of this paper was circulated under the title “Professional service outsourcing, asymmetric information and wage inequality.”
Keywords
- Double-sided adverse selection
- Endogenous principal
- Hierarchies
- Optimal contracting
- Professional service firms
- Venture captial
ASJC Scopus subject areas
- Economics and Econometrics