Control vs. Incentive—the Optimal Allocation of Ownership

The paper first differentiates “control” and “incentive”. Then it shows that integration in which the principal gets ownership of the physical assets necessary for the agent to create values enhances control of the principal over the agent’s human capital and thus improve coordination ex post, but that reduces the agent’s ex ante incentive to make human capital investment and ex post incentive to exert effort. Thus optimal ownership structure is determined by the balance of control vs. incentive and integration happens if and only if benefit of coordination outweighs the incentive losses.