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The B.E. Journal of Theoretical Economics

Editor-in-Chief: Schipper, Burkhard

Ed. by Fong, Yuk-fai / Peeters, Ronald / Puzzello , Daniela / Rivas, Javier / Wenzelburger, Jan

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Sequential Investments, Know-How Transmission, and Optimal Organization

Tsung-Sheng Tsai1 / Sheng-Chiao Kung2

1National Taiwan University,

2National Tsing Hua University,

Citation Information: The B.E. Journal of Theoretical Economics. Volume 11, Issue 1, ISSN (Online) 1935-1704, DOI: 10.2202/1935-1704.1748, December 2011

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Published Online:

In a two-stage sequential investment problem, a principal can use either a single agent or two separate agents to execute the project. The final outcome of the project depends upon both the agent's investments and the first-stage outcome. The principal wishes to stop the project when the first stage is a failure; however, she may not know the first-stage outcome, so that she has to pay the agent a rent to extract that information. Furthermore, the first-stage agent can transmit his know-how to the second-stage agent. Although there is a transmission cost under separate agency while there is no cost under single agency, single agency is not always optimal. This is because the transmission cost can reduce the agent's incentive to continue the project so that the information rent can be lower under separate agency. Hence, the principal may prefer separate agency more even when the transmission cost becomes larger.

Keywords: sequential investments; know-how transmission; optimal organization

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