Joint paper with Maarten Pieter Schinkel (ACLE) and Jan Tuinstra (CeNDEF).

We model public agency decisions in a principal-agent framework with multi-tasking and information asymmetry to study how available resources and institutional structure affect performance. The agency has a two-level organizational structure and an externally set budget. The head of the agency is concerned with overall performance, but also has an incentive to extract part of the resources for non-case specific activities, such as advocacy. The head designs contracts offered to expert case handlers, who, based on their talent and the contract offered, subsequently choose which type of case to pursue: highly rewarding complex tasks with an uncertain outcome, or basic minor tasks. Its assigned budget can change not only the scale, but also the type of the tasks the agency will engage in through the head’s optimal allocation of resources. Budget cuts over a certain threshold may cause an extensive restructuring away from activities that require more expertise and yield a major outcome. We find that social welfare is non-monotonic and discontinuous in the budget, so that at a jump discontinuity an infinitesimal budget cut may lead to a substantial increase in welfare. Merging two or more agencies pools their talent distributions and resources, to affect agency priorities. When both agencies initially have highly talented experts, the head’s choice of post-merger budget allocation may decrease performance on more complex tasks. Moreover, if a merger is accompanied with a joint budget cut, complex tasks may be abandoned altogether. If pre-merger expertise levels differ, it may be optimal for the head to decrease welfare through: (i) reallocation of budget towards the less productive agency, and (ii) a subsequent intra-agency shift in the focus towards a less socially desirable task composition. Competition authorities are discussed as one illustration of the policy implications for institutional structure.