Reducing incremental costs associated with the delegation of incentive contracting decisions: An analysis of planning and control decisions in a manufacturing setting in the presence of moral hazard

We compare and contrast two specific regimes involving the centralization and delegation of the incentive contracting decision in manufacturing organizations. In the centralization regime, a single individual simultaneously makes the allocation of demand to production facilities and determines the incentive compensation scheme for the managers at the facilities. Under the delegation regime, the demand allocation is decided upon initially by a superior and the incentive contracting decision is subsequently made by a subordinate, who is neither of the two managers in charge of the production facilities. Using the principal-agent paradigm, which assumes that the managerial efforts are unobservable, we demonstrate that the centralization regime performs no worse than the delegation regime. For situations where strategic or other requirements necessitate firms to opt for the delegation of the incentive contracting decision, we propose a heuristic that significantly increases the likelihood of mimicking the allocation and contracting decisions made under the centralized regime. (C) 2003 Elsevier B.V. All rights reserved.