Information, Incentives, and Organizational Mode

We examine the choice of organizational mode for a two-stage production process wherein cost realizations at each stage are observed only by the producing party. When these costs are positively correlated, the principal prefers to undertake second-stage production herself. When the correlation is negative and sufficiently small, she will prefer that the agent who performs the first stage also perform the second. For large negative correlation, either mode might be preferred. When costs are uncorrelated, the principal is indifferent between modes.