Incentives Between Firms (and Within)

This paper reviews the significant progress in “agency theory” (i.e., the economic theory of incentives) during the 1990s, with a special focus on applications to supply transactions. I emphasize six recent models, in three pairs: (1) new foundations for the theory of incentive contracts, (2) new directions in incentive theory, and (3) new applications to supply transactions. By reviewing these six models, I hope to establish three things. First, the theory of incentive contracts needed but has received new foundations. Second, new directions in incentive theory teach us that incentive contracts are not the only source of incentives. Finally (and especially relevant to supply transactions), the integration decision is an instrument in the incentive problem.