An Incomplete Contract Approach to Authority in Organizations for Choice and Execution

Abstract: We consider an incomplete contracting model with a principal and an agent, in which the decision process consists of project choice and execution effort, and investigate the optimal allocation of authority for project choice. Each party has an imperfectly informative private signal on which project is promising, and the project is successfully executed if and only if the promising project is chosen and the agent exerts effort to execute the project. Since the principal chooses the project based on her private signal when she has the authority (centralization), the agent's confidence on the promising project has more uncertainty than the agent has the authority (delegation). Consequently, it might be optimal to allocate authority to the party who has less precise information on the promising project. Furthermore, we demonstrate that whether contractible delegation and empowerment could have a nonnegligible gap even though the parties have no conflict on the desired project.