Gaining Control by Losing Control

Abstract

We study an agency model with two sequential tasks, an initial task (e.g., development), which requires unverifiable effort, and a final task (e.g., production), whose environment is privately known only to the agent. The principal can either perform the initial task herself ( hands‐on management ) or delegate it to the agent ( hands‐off management ). We show that when the cost of effort for the initial task is low, hands‐on management is optimal, as it mitigates the distortion caused by agent shirking. However, as the cost of effort increases, hands‐off management becomes preferable. Under hands‐on management, the principal's inability to commit leads her to overinvest in the initial task, which in turn exacerbates inefficiencies in the final task due to the agent's information rent. In contrast, hands‐off management, despite the agent's shirking incentive, helps better target effort toward favorable project environments. Our analysis also reveals how effort costs can create systematic biases toward one management style over the other.