Organizational Design For Business Units

This paper studies empirical differences across decentralized firms with respect to the allocation of tasks from the parent firm to its business units and the level of compensation risk imposed on business unit managers. We structure our empirical analysis around two hypothesized determinants of these organizational structure decisions: the parent firm's task expertise relative to that of the business unit's and the relative importance of the business unit to the performance of the parent firm. We develop a principal-agent model of the task allocation and compensation risk decisions as a function of these two determinants, and test several research hypotheses suggested by this model. In our analysis, we use the term relative expertise to refer to the competence of the parent, relative to the business unit manager, to make the division's operating decisions. Relative task expertise can be characterized in several ways; we consider three such characterizations and, using our model, find that they have different implications for the allocation of tasks and the imposition of compensation risk in decentralized firms.1 We label our three characterizations of relative expertise as follows: Cost