Observability and Endogenous Organizations

This paper establishes a relationship between the observability of common shocks and optimal organizational design under a multiagent moral hazard environment. The choices of organization and investment on information about common shocks are determined jointly, in a Walrasian equilibrium model where the commodities traded are memberships in organizations. Numerical results reveal that both cooperative and individualistic regimes can coexist in equilibrium. We show that, with sufficient information about common shocks, a cooperative organization will be optimal even when outputs are highly correlated. This contradicts the conventional result from Holmström and Milgrom (1990), but is consistent with the empirical observation that cooperative arrangements may be more prevalent when outputs are correlated. Indeed, when organization and investment on information are jointly determined, the relationship between correlation of outputs and organization is subtler. The interplay between organization, investment in information, and inequality is thus analyzed. JEL Classification Numbers: D23,D71,D85,O17.