Incomplete Contracts and the Internal Organization of Firms

Abstract

We survey the theoretical and empirical literature on decentralization within firms. We first discuss how the concept of incomplete contracts shapes our views about the organization of decision-making within firms. We then overview the empirical evidence on the determinants of decentralization and on the effects of decentralization on firm performance. A number of factors highlighted in the theory are shown to be important in accounting for delegation, such as heterogeneity and congruence of preferences as proxied by trust. Empirically, competition, human capital and IT also appear to foster decentralization. There are substantial gaps between theoretical and empirical work and we suggest avenues for future research in bridging this gap.

Does Delegation Increase Worker Training?

“…In both cases, delegation persists as a feasible outcome when the loss of control implied by delegation proves less costly for the principal than the loss of information under centralization. 4 Estimation by Aghion, Bloom, and Van Reenan (2014) confirms that the congruence of preferences (as proxied by trust) helps determine delegation. Itoh, Kikutani, and Hayashida (2008) show that delegation from core to affiliated Japanese firms is associated with incentives for accountability.…”

“…Our investigation remains pertinent as delegation and decentralization of decision-making within firms have become increasingly common since the late 1970s, being most evident in Scandinavian and Anglo-Saxon countries (Aghion, Bloom, and Van Reenan 2014). 2 This growth in 1.…”

Social Capital, Trust and Entrepreneurial Productivity

“…Therefore, production in countries with higher social capital and trust will take place in organizations whose management technology will have lower values of parameter β than the management technologies dominating in countries with lower social capital and lower generalized trust. Aghion and Tirole (1997) and Aghion et al (2014) formally prove that optimal decentralization of decision-making in hierarchical organizations is greater in high trust environments because collaboration among specialists will take place in conditions of higher goal congruence. Gur and Bjornskov (2017) find a strong positive association between trust and delegation in cross-country data, but only for developed countries.…”

“…Occupational choice models predict that the equilibrium number of entrepreneurs will be lower and the average productivity per entrepreneur (employees per entrepreneur) higher in economies with low organizational size diseconomies (low marginal management costs) than in economies with high organizational size diseconomies (Rosen, 1982). There is also theory (Aghion and Tirole, 1997;Aghion et al, 2014) supported by empirical evidence (Bloom et al, 2012;Gur and Bjornskov, 2017) showing that trusts favours effective decentralization of decisions in organizations, reducing management cost and consequently reducing the internal costs of growth. Therefore, trust as facilitator of decentralized organizations creates a link between social capital as determinant of trust (Coleman, 1990;Adler and Kwon, 2002;Glaeser et al, 2002;Kwon and Adler, 2014) and the number and productivity of entrepreneurs in the economy.…”

Reputation versus information: The delegation policy when the principal has reputational concerns

“…The role of delegation is to make public signals noisy about her type and to shift the blame to the agent. 4 The above 3 For an overview of the contract theory literature on the notion of authority within organizations, see Aghion, Bloom, and Van Reenen (2014), Bolton and Dewatripont (2012), and Gibbons, Matouschek, and Roberts (2012). 4 Such blame-avoiding behaviors are certainly not rare outside politics.…”