CENTRALIZED AND DECENTRALIZED CONTRACTS IN A MORAL HAZARD ENVIRONMENT

We study the optimal allocation of the contracting capacity in a moral hazard environment. Centralizing is superior when the principal is ab le to establish all the contracts with the agents simultaneously and s he is able to monitor side contracting between the agents. Otherwise, decentralizing can be a superior strategy. We apply our results to a f irm's decision on which outlets to franchise. They suggest that franch ising is more likely to occur the further the store is from headquarte rs, the more isolated it is and in those activities where the risk is low, This conclusion is consistent with empirical studies.