Delegated Management and Contract

We explore the value of delegating control over production and contract de-sign for workers or suppliers to a manager/intermediary not directly involved in production but possessing specialized information. Suppliers and the intermediary can collude with one another. Delegation to the intermediary is compared with arrangements where the owner does not involve the intermediary at all, i.e., either retains control personally or delegates control to one of the suppliers. The advan-tage of delegating control to the intermediary is the value of the latter’s specialized information, which improves coordination of production and reduces supplier rents. The cost of intermediation is that it creates an extra layer within the hierarchy with attendant agency problems: the intermediary can act strategically with respect to her private information, and collude with suppliers against the owner’s interests. Technological characteristics determine the outcome of this tradeoff. If the two inputs supplied are substitutes (e.g., procurement auctions), the agency costs of intermediation dominate the benefits: it is optimal for the owner to not involve the intermediary and retain control. If the two inputs are complements, this can get reversed whence delegating control to the intermediary is optimal. Delegation to the intermediary always dominates delegation to a supplier. Implications for relative costs and benefits of U-form, M-form hierarchies and matrix organizational structures are subsequently discussed