Agency theory, innovation, and the rules of the game

The dissertation provides an economic exploration of how institutional arrangements in combination with incentive structures deal with the knowledge issues that arise when trying to determine when it is optimal to encourage innovation. It explores the role of background rules and institutional relations in the formation of incentive systems. It also explores the limits of incentive systems in addressing the knowledge issues associated with innovation. The dissertation looks at the tradeoffs between monitoring and innovation within firms in a simple two-tiered principal/agent framework. It provides some insight into the issue of when monitoring provides the low cost method of improving quality and when innovation is the better way of improving quality. The dissertation then takes an empirical look at differing methods of ensuring high quality within the automobile industry. It uses hedonic regression techniques to look at consumer sensitivity to quality. The dissertation looks at the changes in the demand for quality in the United States over time. it explores how those differences effect the decision of whether to provide quality through monitoring or innovation. Finally, it looks at the theoretical and empirical issues related to the question of whether inefficient path dependency exists in the automobile industry and whether lock-in occurs. The dissertation contends that while the existence of a rules systems can create some rigidity in the system internal entreprenuership will act as a mechanism for change.