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Profit sharing and monitoring in partnerships

Steven Huddart and Pierre Jinghong Liang

We consider partnerships among risk-averse professionals endowed with (i) a risky and personally-costly production technology and (ii) a personally-costly monitoring technology providing contractible noisy signals about partners' productive efforts. Partners shirk both production and monitoring tasks because efforts are unobservable. We characterize optimal partnership size, profit shares and incentive payments when every partner performs the same tasks, and show that medium-sized partnerships are dominated by either smaller or larger partnerships. Prohibiting some partners from monitoring increases the incentives for others to monitor. We illustrate how task assignments and incentives interact, leading to improvements in partner welfare.

Journal of Accounting & Economics Volume 40, Numbers 1-3 (December 2005) 153-187

JEL Classification: C72 L25 M52

Keywords: incentive contracting, monitoring, risk aversion, syndicates

this draft: May, 2005

Download a pre-publication version of the paper from SSRN.

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Steven Huddart
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
(814) 865-3271
(814) 863-8393 fax
huddart@psu.edu
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