Abstract We build a hierarchical model of contractual relationships under moral hazard to address issues about subsidiarity, i.e. optimal (de)centralization of incentive industrial policies at the national level or at the European Community level. Incentive policy is viewed as an incentive contract for producers who take unobservable decisions that have spillover effects across Member States. A Community Agency designs contracts for producers and contractual compensatory transfers between States on the basis of its observations; then national regulators and their home producers negotiate, according to a generalized Nash bargaining, a national contract that complements the Community contracts, given that national regulators will have access to more observations on the producers activities. In this setting, we show that full centralization is never optimal; we give sufficient conditions for complete decentralization to be optimal; and when both policies are present, we characterize how they interact to provide incentives to producers.