| We build a model to address the question of why firms fail to adapt to changes in the environment. In the model, the principal has to induce the agent to acquire and transmit information that is helpful in making a project choice. The agent has two tasks: to acquire and transmit information, and then to produce. As the main result, we identify a trade-off between the amount of information flow and rent extraction. This trade-off can make the optimal mechanism exhibit an inertia toward the status quo. Our model predicts, in particular, that a more efficient firm tend to exhibit more inertia than a less efficient firm. Task separation can be an organizational response intended to improve flows of information. This offers a rationale for the separation of day-to-day operating decisions from long-term strategic decisions stressed by Williamson. Finally, in a dynamic extension, we examine how the agency relationship affects the pattern of innovation. The extension predicts that incumbents' innovations tend to be focused on established market segments while neglecting niches created by changes in the environment. |