The Separation of Decision Making and Risk Bearing: Organizational Form and the Decision to Go Private
IFA Working Paper 186
Posted: 16 Sep 1999
Date Written: February 7, 1994
The paper investigates the hypothesis that the separation of ownership and control is made viable by an organizational structure that separates decision making from monitoring. The paper analyses the choice of organizational form and contrasts a hierarchy where executive management is monitored and remunerated by a director who acts as a supervisory agent, and an entrepreneurial firm in which all control rights are concentrated in the hands of a single agent. It is shown how the organizational form affects the allocation and the tradeoff between risk-sharing and incentives. The model predicts that the hierarchy is a dominant choice in environments where monitoring information is precise, whereas the entrepreneurial firm is a better choice if productive efforts are difficult to monitor. Also, more efficient hierarchies have a lower correlation between shareholder value and managerial compensation. The paper shed some light on the decision to go private and on the reverse-LBO phenomenon.
JEL Classification: G30, G34
Suggested Citation: Suggested Citation