When the delegation of task occurs within the firm, a major conclusion of the above analysis is that, because of asymmetric information, the firm does not max- imize the social value of trade, or more precisely its profit—a maintained assump- tion of most economic theory. This lack of allocative efficiency should not be considered as a failure in the rational use of resources within the firm. Indeed, the point is that allocative efficiency is only one part of the principal’s objective. The allocation of resources within the firm remains constrained optimal once informa- tional constraints are fully taken into account.
This systematic deviation away from profit maximization can be interpreted as an X-inefficiency à la Leibenstein (1966), who has stressed the management failures that take place within the largest firms, i.e., those that are the most likely to suffer from significant internal informational problems.
Williamson (1975) has also advanced the view that various transaction costs may impede the achievement of economic transactions. Among the many ori- gins of these costs, Williamson stresses informational impactedness as an important source of inefficiency. Clearly, even in a world with a costless enforcement of contracts, a major source of allocative inefficiency is the existence of asymmet- ric information between trading partners. Of course, another important insight of Williamson’s analysis is that transaction costs may be mitigated by the choice of convenient organizational forms. This point does not contradict our interpreta- tion of transaction costs as coming from informational problems if one is ready to accept the view that various organizational forms generate different degrees and costs of asymmetric information between partners, an issue which is clearly high on the current research agenda of organization theory.
The idea that various organizational forms are associated with different infor- mation structures has been used by some authors to provide a theory of vertical integration. Arrow (1975) suggested that an upstream firm may want to integrate backward and acquire a downstream supplier to reduce the extent of asymmetric information between those two units. An obvious limitation of this approach is that it takes as exogenous the fact that vertical integration improves information. This exogeneity has led to an important debate over the last fifteen years between proponents of this idea (for instance, Williamson 1985) and opponents (such as Grossman and Hart 1986).
One last point is worth stressing. Even though asymmetric information gener- ates allocative inefficiencies, those inefficiencies do not call for any public policy motivated by reasons of pure efficiency. Indeed, any benevolent policymaker in charge of correcting these inefficiencies would face the same informational con- straints as the principal. The allocation obtained above is Pareto optimal in the set of incentive feasible allocations or incentive Pareto optimal. Nevertheless, the pol- icymaker might want to implement different trade-offs between efficiency and rent extraction, as we will see in section 2.15.1 in the archetypical case of regulatory intervention. In this case redistribution would be the motivation for public policy.
Source: Laffont Jean-Jacques, Martimort David (2002), The Theory of Incentives: The Principal-Agent Model, Princeton University Press.