Alignment of Interests and the Governance of Joint Ventures1

The paper analyzes optimal governance structures for the provision of a common input. Monitoring by the future users of the input may improve its quality. Monitoring has a public good component in that it benefits all users, as well as a conflict of interest component in that a monitor may use her proprietary information to bias input choice to her benefit and to the detriment of the other users. The paper compares three familiar governance structures, outside (investor) ownership, vertical integration (undivided control by a user), and joint venture, with the optimal mechanism. Vertical integration gives the integrated user an incentive to monitor but generates biased decision making. In contrast, a joint venture, by requiring Pareto-improving decisions, yields unbiased decision making, but may provide too little incentives to monitor and generate footdragging and deadlocks, especially when the users’ objectives are quite divergent. Often, the size of the conflict of interest among users can be reduced, at a cost, through contractual provisions. Our comparative statics exercises unveil a stark contrast between vertically integrated governance and the joint venture in this respect. Under vertical integration, negative externalities imposed by biased decision making reduce efficiency and do not affect incentives to monitor. In a joint venture, they do not affect decision making but increase the incentive to monitor. Parties to a joint venture are already protected by their control rights and further protection turns out to be counterproductive. We therefore argue that joint venture contracts should be less detailed and offer fewer exit opportunities than contracts protecting non controlling stakeholders. JEL Classification : D23, G32, L3