Delegation and the theory of the firm

Abstract

The use of thugs or sadists for the collection of extortion or the guarding of prisoners, or the conspicuous delegation of authority to a military commander of known motivation, exemplifies a common means of making credible a response pattern that the original source of decision might have been thought to shrink from or to find profitless, once the threat had failed. Schelling (1960, pp. 142–3). If control of my decisions is in the hands of an agent whose preferences are different from my own, I may nevertheless prefer the results to those that would come about if I took my own decisions. This has some interesting implications for the theory of the firm. For example, in markets where firms are interdependent, it is not necessarily true that maximum profits are earned by firms whose objective is profit-maximization. This can be seen in a simple example of entry deterrence. Firm A is deciding whether or not to enter a market currently monopolized by firm B . If A enters, B (or rather its managers) must decide whether to respond aggressively or in an accommodating fashion. Entry is profitable for A if and only if B does not fight. Faced with the fact of entry, it is more profitable for B to accommodate than to fight, but B 's profits are greater still if there is no entry.

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