DP5802 When Does Coordination Require Centralization?

Author(s): Ricardo Alonso, Wouter Dessein, Niko Matouschek
Publication Date: August 2006
Keyword(s): cheap talk, coordination, decision rights, incomplete contracts
JEL(s): D23, D83, L23
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=5802

This paper compares centralized and decentralized coordination when managers are privately informed and communicate strategically. We consider a multi-divisional organization in which decisions must be responsive to local conditions but also coordinated with each other. Information about local conditions is dispersed and held by self-interested division managers who communicate via cheap talk. The only available formal mechanism is the allocation of decision rights. We show that a higher need for coordination improves horizontal communication but worsens vertical communication. As a result, no matter how important coordination is, decentralization dominates centralization if the division managers are not too biased towards their own divisions and the divisions are not too different from each other (e.g. in terms of division size).