Steven J Huddart
Pennsylvania State University
Pierre Jinghong Liang
Carnegie Mellon University
Abstract: We characterize optimal linear profit sharing contracts among identical risk-averse partners endowed with a risky and personally costly production technology. Since individual output is unobservable, partners shirk productive effort, which limits optimal partnership size. When partners are further endowed with a personally costly monitoring technology that provides contractible noisy signals about partners' productive efforts, partner draws may depend on these signals and firm output. However, partners also shirk the monitoring task, which limits optimal partnership size. In firms with many partners, improvements in joint surplus obtain when one partner specializes in monitoring, so that task specialization emerges endogenously.
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