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Control Versus Incentive - The Optimal Allocation of Physical Capital Ownership

The economy consists of a principal, an agent and a physical capital. Both of the latter two are indispensable to create value. The agent uses the capital to do either the independent project or the one that coordinates the principal's need. The paper shows that the arrangement of the principal owning the capital enhances her control over the project choice, but reduces ex ante incentive of the agent to invest in his human capital and/or ex post incentive to exert effort. Thus the optimal ownership allocation is determined by the balance of control versus incentive and the principal ownership happens if and only if the benefit of coordination outweighs the incentive losses. The paper also presents a rationale for M-form organizations, where the physical capital is centralizedly owned by the whole firm, but each division is accountingly independent. The former is to keep control while the later is to give incentive.