When Does Centralization Undermine Adaptation?

Abstract

We revisit the classic problem of optimally allocating decision rights in a multi-divisional organization. To be able to adapt its decisions to local conditions, an organization has to rely on self-interested division managers to collect and disseminate the relevant information. We show that if (a) communication takes the form of verifiable dis- closure and (b) there is no uncertainty about which division’s success will be more critical to the organization’s overall performance, then centralization always dominates decentralization in generating information, and therefore may even lead to more adaptative decisions. However, when the above uncertainty in the headquarters’ decision criterion is present, centralization can perform poorly in motivating information acquisition, and particularly so when it is highly important to coordinate the activities of different divisions. As a result, a decentralized authority structure can be optimal even with an arbitrarily strong coordination motive.

Keywords: centralization, decentralization, coordinated adaptation, information acquisition, verifiable disclosure

JEL Classification: D82, M52