Tradeoff between Equity and Efficiency in Revenue Sharing Contracts

We investigate the problem of setting revenue sharing rules in a team production environment with a principal and two agents. We assume that the project output is binary and that the principal can observe the level of agents' actual effort, but does not know the production function. Identifying conditions that ensure the efficiency of the revenue sharing rule, we show that the rule of equal percentage markups can lead to inflation of project costs. This result provides an explanation for project cost overruns other than untruthful cost reporting.