DP15602 Organizational Structure and Investment Strategy

Author(s): Gyöngyi Lóránth, Alan Morrison, Jing Zeng
Publication Date: January 2021
Date Revised: January 2021
Keyword(s): branch, multinational business, Organizational structure, subsidiary
JEL(s): G32, G34, L22
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15602

We show that a firm can use its organizational structure to commit to an investment strategy. The firmdelegates sequential search and project management tasks to a manager. Ex post, the firm turns away projects that generate high project management rent. However, because the expectation of such rent serves to defray the manager's search cost, investment might be optimal ex ante. A leveraged subsidiary mitigates this time-inconsistency problem by creating ex post risk-shifting incentives that counteract underinvestment. Subsidiaries are more valuable for projects with costly search, intermediate management costs, and returns that are uncorrelated with the existing business.