Hierarchical Decentralization of Incentive Contracts

Agents in a hierarchy are commonly delegated authority to communicate and contract with agents at lower levels. While delegation reduces the burden of communication and information processing on the principal, it also introduces additional incentive problems. We find that with sufficient monitoring of the agents' contributions to joint production, and a particular sequence of contracting, the additional incentive problems inherent in delegation can be completely resolved. These conditions are generally also necessary for delegation to achieve second-best results.