Allocation of Decision-making Authority

Milton Harris and Artur Raviv

Review of Finance, 2005, vol. 9, issue 3, 353-383

Abstract: This paper addresses the question of what determines where in a firm's hierarchy investment decisions are made. We present a simple model of a CEO and a division manager to analyze when the CEO will choose to allocate decision-making authority over an investment decision to a division manager. Both the CEO and thedivision manager have private information regarding the profit maximizing investment level. Because the division manager is assumed to have a preference for "empire", neither manager will communicate her information fully to the other. We show that the probability of delegation increases with the importance of the division manager's information and decreases with the importance of the CEO's information. A somewhat counterintuitive result is that, in some circumstances, increases in agency problems result in increased willingness of the CEO to delegate the decision. We also characterize situations in which the CEO prefers to commit to an allocation of authority ex ante, instead of deciding based on her private information.Finally, even though the division manager is biased toward larger investments, we show that under certainconditions, the average investment will be smaller when the decision is delegated. These results help explain some findings in the empirical literature. A number of other empirical implications are developed.

Date: 2005
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