Abstract

Bureaucracy and influence activities consume a great deal of managers’ time and effort in an organization. These activities are surplus
destroying in the sense that they produce no direct output or information. This paper suggests a positive role for these activities. We
develop a model for allocation in internal capital markets that takes a mechanism design perspective and incorporates both costly inspection and money burning (e.g. bureaucracy, influence activities) as tools for the headquarters to pursue optimal allocations. We find that the optimal mechanism deploys both the instruments of costly inspection and money burning, often at the same time on an agent.