Diseconomies of Scale in Employment Contracts

Eric Bennett Rasmusen, Kelley School of Business, Indiana University
Todd Zenger, John M. Olin School of Business, Washington University

Abstract

We find that small teams can write more efficient incentive contracts than large teams when agents choose individual effort levels but the principal observes only the joint output. This result is helpful in understanding organizational diseconomies of scale and is consistent with both existing evidence and our own analysis of data from the Current Population Survey. Our modelling approach, similar to classical hypothesis testing, is of interest because we need not derive the optimal contract to show the advantage of small teams.