DP5391 Externalities, Communication and the Allocation of Decision Rights

Author(s): Helmut Bester
Publication Date: November 2005
Keyword(s): authority, decision rights, externalities, imperfect information, incomplete contracts, theory of the firm
JEL(s): D23, D82, L22, P14
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5391

This paper views authority as the right to undertake decisions that impose externalities on other members of the organization. When only decision rights can be contractually assigned to one of the organization's stakeholders, the optimal assignment minimizes the resulting inefficiencies by giving control rights to the party with the highest stake in the organization's decisions. Under asymmetric information, the efficient allocation of authority depends on the communication of private information. In the case of multiple decision areas, divided control rights may enhance organizational efficiency unless there exist complementarities between different decisions.