Externalities, communication and the allocation of decision rights

Abstract

This paper views authority as the right to undertake decisions that impose externalities on other members of the organization. When only decision rights can be contractually assigned to one of the organization's stakeholders, the optimal assignment minimizes the resulting ineffciencies by giving control rights to the party with the highest stake in the organization's decisions. Under asymmetric information, the effcient allocation of authority depends on the communication of private information. In the case of multiple decision areas, divided control rights may enhance organizational effciency unless there exist complementarities between different decisions.