Information Processing : Contracts versus Communication

We consider the trade-off between imperfect control and communication in organizations. A principal anticipates receiving private information and hires an agent to take an action for her. She has the ability to contractually tie the agent's action to the state, but this control is incomplete. States not covered by a contract induce a communication game. Close alignment of interests favors communicating and, thus, ceding authority to the agent, and vice versa. Contracting increases the number of actions that can be induced through communication. Optimal contracts that do not cover all states both substitute for and facilitate communication