Technical Change, Moral Hazard, and the Decentralization Penalty when the Set of Possible Efforts Is Infinite

This paper considers two modes of organizing a one-worker firm and compares them with regard to social welfare. In the Centralized mode, worker-control techniques, together with adequate compensation, insure that the worker chooses a surplus-maximizing effort. In the Decentralized mode the worker is not controlled. Instead a profit-driven Principal contracts with a self-interested Agent (the worker) who freely chooses an effort and bears its cost. The Principal rewards the Agent once she sees the revenue generated by the Agent's hidden choice. The welfare loss when the Principal induces her favorite effort is called the Decentralization Penalty. For certain common contract types, the paper studies the behavior of the Penalty in response to changes in production technology. In a previous paper the set of possible efforts was finite. In this paper the set is the entire interval [0,1]. The Decentralization Penalty turns out to be continuous and to have a unique peak. Early improvements in technology cause a rise in the Penalty and further improvements lead to the Penalty's peak. Then the Penalty descends. When technology is sufficiently advanced, the Penalty is zero, because surplus-maximizing effort and the effort the Principal induces are both the highest possible effort (the effort 1). While advances in worker-control technology always strengthen the social-welfare case for the Centralized mode, advances in production technology may do the opposite