When Does Coordination Require Centralization?, American Economic Review
We consider a multi-divisional organization in which decisions must be responsive to local circumstances but also coordinated with each other. Divisional managers are privately informed and communicate their information strategically. The only available formal mechanism is the allocation of control over decisions. We show that a higher need for coordination improves communication under decentralization but worsens communication under centralization. As a result, a decentralized organization can be optimal even when coordination is extremely important. Centralizing decision making in an independent headquarter is optimal when division managers are sufficiently biased towards their own divisions' profits and the need for coordination is sufficiently big. Centralizing decision making in one of the operating divisions is optimal if this division has more private information than the other divisions, the own division bias of division managers is sufficiently small and the need for coordination is sufficiently big. Finally, division managers communicate more information to an independent headquarter than they do to each other. As a result, a headquarter can be better informed about local circumstances than the division managers, in spite of the fact that the headquarter does not directly observe any information itself.
Niko Matouschek, Ricardo Alonso, Dessein Wouter
Matouschek, Niko, Ricardo Alonso, and Dessein Wouter. 2008. When Does Coordination Require Centralization?. American Economic Review. 98(1): 145-79.