Coalitions, incentives, and risk sharing

Abstract

This paper analyzes coalitional behavior in principal-multiagent relationships with moral hazard, and identifies cases where the principal prefers agents to form a coalition via side contracting. The paper first shows that when agents' efforts are mutually unobservable so that their side contracts cannot be contingent on their efforts, the possibility of mutual insurance through monetary side contracts never makes the principal better off. It is then shown that when the agents can monitor each other's efforts perfectly, coordination in effort choice through side contracts contingent on efforts and outputs enables the principal to reduce the cost of implementing given efforts. This result holds when no production externality exists and noise terms are independent, when there is team production and the agents are sufficiently homogeneous, or when production externalities such as mutual "help" are important and there is a pressure toward "egalitarianism."