Performance Monitoring and Incentives in Hierarchies

We consider a principal-multi agent model that features a three-tier hierarchy, defined as a setting where the principal contracts with an agent-manager and delegates to the manager some authority to contract with other agents. A key highlight is that incentive compensation, performance monitoring, and the hierarchical structure (the extent to which contracting authority is delegated to the manager) are simultaneously determined. In general, we find that productivity and monitoring exhibit opposite patterns in a hierarchy. That is, at higher hierarchical levels effort incentives are higher but performance monitoring and pay-for-performance sensitivity is lower, even for agents who are otherwise comparable. For instance, we find that agents working for the agent-manager are less productive even though they are monitored more intensively than comparable agents elsewhere in the hierarchy. The flip side is that an agent-manager entrusted with authority to evaluate others is (implicitly) motivated to be more productive even though such authority reduces the need to monitor his performance. The choice of a hierarchical structure then balances the benefits of a more productive (but less monitored) manager against the costs of less productive (but more monitored) lower-level workers. Overall, our findings contribute to the growing literature that documents complementarities among organizational design choices