We propose a theory of supervision with endogenous transaction costs. A principal delegates part of his authority to a supervisor who can acquire soft information about an agent's productivity. If the supervisor were risk-neutral, the principal would simply make the better informed supervisor...

This paper derives an Equivalence Principle between organizational forms of supervisory and productive activities. We consider an organization with an agent privately informed on his productivity and a risk averse supervisor getting signals on the agent's type. In a centralized organization, the...