Capital Allocation and Information Processing A Comparison between Hierarchical and Electronic Market Coordination Mechanisms

Recent research has dealt with questions of efficient coordination of economic activities. The considered alternatives range from (perfect) markets to (perfect) hierarchies with some hybrid forms in between. One of the main results of this research, especially of transaction cost theory, is that each alternative could be efficient, depending on certain characteristics of transactions and situations. This implies that each activity has to be examined for the appropriate coordination mechanism to choose. The choice of mechanisms has to be reconsidered periodically to avoid inefficient results caused by changing conditions. In our setting we address the problems large international corporations face when operating in a complex and dynamic business environment, trying to allocate investment capital to their decentralized units. The paper investigates whether the incorporation of an internal electronic market into an existing hierarchy can lead to an allocation of the scarce resource which is superior to the allocation resulting from a conventional hierarchical decision process. The underlying model is based on a situation with information asymmetries between the corporate headquarters and the operating units. We compare the capital allocation process with respect to its ability to allocate investment capital efficiently and to the costs of the process. The analysis shows that under certain conditions an internal electronic market is advantageous compared to a conventional hierarchical allocation. + This paper has been worked out within the Project "IKS-basierte Koordination dezentraler Finanzprozesse mit Hilfe elektronischer Märkte" funded by the Deutsche Forschungsgemeinschaft. * University of Augsburg, Department WISO, D-86135 Augsburg, Germany; email: {Jens.Hinrichs| Stefan.Klein}@wiso.uni-augsburg.de; phone: ++49 (821) 598-4140, fax: ++49 (821) 598-4225