Accounting Papers

Document Type

Journal Article

Date of this Version

12-2007

Publication Source

Journal of Accounting Research

Volume

45

Issue

5

Start Page

915

Last Page

946

DOI

10.1111/j.1475-679X.2007.00255.x

Abstract

There is growing interest in the use of markets within firms. Proponents have noted that markets are a simple and efficient mechanism for allocating resources in economies in which information is dispersed. In contrast to the use of markets in the broader economy, the efficiency of an internal market is determined in large part by the endogenous contractual incentives provided to the participating, privately informed agents. In this paper, we study the optimal design of managerial incentives when resources are allocated by an internal auction market, as well as the efficiency of the resulting resource allocations. We show that the internal auction market can achieve first-best resource allocations and decisions, but only at an excessive cost in compensation payments. We then identify conditions under which the internal auction market and associated optimal incentive contracts achieve the benchmark second-best outcome as determined using a direct revelation mechanism. The advantage of the auction is that it is easier to implement than the direct revelation mechanism. When the internal auction mechanism is unable to achieve second-best, we characterize the factors that determine the magnitude of the shortfall. Overall, our results speak to the robust performance of relatively simple market mechanisms and associated incentive systems in resolving resource allocation problems within firms.

Copyright/Permission Statement

This is the peer reviewed version of the following article: BAIMAN, S., FISCHER, P., RAJAN, M. V. and SAOUMA, R. (2007), Resource Allocation Auctions within Firms. Journal of Accounting Research, 45: 915–946., which has been published in final form at doi: 10.1111/j.1475-679X.2007.00255.x. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving http://olabout.wiley.com/WileyCDA/Section/id-820227.html#terms.

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Date Posted: 27 November 2017

This document has been peer reviewed.