Preliminary and Incomplete Appendix: Decision Rights, Payoff Rights, and Relationships in Firms, Contracts, and Other Governance Structures

This paper explores how governance structures (defined as ex ante allocations of decision rights and payoff rights) affect how parties adapt to changing circumstances. Our model allows for an arbitrary number of parties and an arbitrary number of decision rights, payoff rights, and assets (inseparable bundles of decision rights and payoff rights). We solve for the governance structure that maximizes expected social surplus under spot adaptation, and also for the (typically different) governance structure that maximizes surplus under relational adaptation. We offer three complementary interpretations of our model: a theory of the firm without specific investments; a theory of decision rights allocated between firms via contract; and a theory of alternative governance structures such as alliances, networks, and joint ventures. * Sections 3 and 4 of this paper may become a shared technical appendix for two of our papers: “Contracting for Control” and “Relational Contracts in Strategic Alliances.” In addition to the acknowledgements in those papers, we are very grateful for discussions with Oliver Hart, Bengt Holmstrom, and Jon Levin, and for research support from Harvard Business School (Baker), MIT’s Program for Research on Innovation in Markets and Organizations (Gibbons), and USC’s Marshall School (Murphy). USC FBE/CLEO APPLIED ECONOMICS WORKSHOP FRIDAY, March 26, 2004 1:30 pm 3:00 pm, Room: HOH-601K presented by Bob Gibbons