Relative Performance Evaluation, Agent Hold-Up and Firm Organization

Abstract

We analyze a situation where common noise makes compensation based on relative performance evaluation (RPE) desirable, but where the agents' ability to hold-up values ex post obstruct the implementation of optimal RPE schemes. The principal can take actions to constrain the agents'hold-up power by limiting their outside options and by protecting property rights, but once these actions are costly, a trade-o¤ between incentive provision and agent control appears. The model contributes to the theory of the …rm. It indicates why …rms, not agents, own assets, and why peer-dependent incentive systems are more common within than between …rms.JEL Classi…cation: D23, J33, L14