Exit Options and the Allocation of Authority

Abstract

We analyze the optimal allocation of authority in an organization whose members have conflicting preferences. One party has decision–relevant private information, and the party who obtains authority decides in a self–interested way. As a novel element in the literature on decision rights, we consider exit option contracts: the party without decision rights is entitled to prematurely terminate the relation after the other party’s choice. We show that under such a contract it is always optimal to assign authority to the informed and not to the uninformed party, irrespective of the parties’ conflict of interest. Indeed, the first–best efficient solution can be obtained by such a contract.