We propose a theory of supervision with endogenous transaction costs. A principal delegates part of his authority to a supervisor who can acquire soft information about an agent's productivity. If the supervisor were risk-neutral, the principal would simply make the better informed supervisor...

This paper shows that supervision with soft information is valuable whenever supervisors and supervisees collude under asymmetric information and proceeds then to derive an Equivalence Principle between organizational forms of supervisory and productive activities. We consider an organization...