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The O‐ring theory of the firm
Author(s) -
Rauh Michael T.
Publication year - 2017
Publication title -
journal of economics and management strategy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.672
H-Index - 68
eISSN - 1530-9134
pISSN - 1058-6407
DOI - 10.1111/jems.12216
Subject(s) - incentive , moral hazard , principal (computer security) , division of labour , limit (mathematics) , function (biology) , division (mathematics) , production (economics) , ring (chemistry) , principal–agent problem , microeconomics , economics , business , management , market economy , computer science , mathematics , mathematical analysis , corporate governance , chemistry , arithmetic , organic chemistry , evolutionary biology , biology , operating system
We develop an O‐ring production function characterized by specialization and division of labor and where shirking or negative shocks can have major adverse consequences. We show that when the principal can monitor individual output, the firm tends be large (potentially larger than first best), with a high degree of specialization and division of labor, weak incentives, and low pay as in traditional nonunion manufacturing. Moral hazard can only limit the size of the firm relative to the first best when the principal can only monitor team output, in which case the firm has the opposite characteristics.