Benefits of delegating decision authority: an incentive contracting perspective

This paper analyzes the benefits of delegating different ranges of decision authority to lower hierarchical levels in an environment with moral hazard and limited liability. A principal as firm owner is confronted with a series of projects which require the productive input of two agents. As projects differ with respect to their task-related inputs, it is essential to acquire information on the necessary input of both agents before starting production. We answer the question of whether the principal should be in charge of acquiring the information (centralization) or one of the agents (decentralization). We explain the existence of both organizational structures on the basis of pure incentive considerations and show that decentralization can be optimal for the principal. Moreover, we explain under which circumstances it is beneficial for the principal to also delegate the incentive contracting authority to the agent that is already in charge of information acquisition (contract decentralization).