DP4072 Optimal Information Management: Organizations versus Markets

Author(s): Micael Castanheira, Mikko Leppämäki
Publication Date: September 2003
Keyword(s): authority, boundaries of the firm, delegation, information processing
JEL(s): D21, D73, L22
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4072

This Paper examines the optimal structure of management when a decision-maker must have a mass of information processed before making a decision. They can either delegate processing tasks inside their own organization, in which case they retain full authority over the agents, or they hand over this authority to an outside supplier by outsourcing these activities. By incorporating authority in a stylized model of information processing, we endogenize the comparative advantage of each form of delegation, and provide novel microfoundations for the make-or-buy decision. We outline precise conditions under which giving up authority is optimal. We also show which tasks should be outsourced to align the preferences of the outside supplier with those of the decision-makers, and thereby maximize the benefits accruing from outsourcing.