Organizational Design : Decision Rights and Incentive Contracts

Meckling (1992) argue that moving a decision away from the inherently best-informed party involves costs in communication and garbling but may lodge it with someone who has better incentives to make good decisions. But generally we expect that incentives are part of the organizational design. Why not just provide incentives to those with the best information so that they make the right decisions? One reason is that the available incentive instruments must serve multiple purposes and designing them to induce better decisions worsens performance against other organizational objectives. Our experience suggests this is a common situation in actual organizations: The means available to affect one sort of behavior or decision inevitably affect the incentives governing other choices. Then the design of incentive schemes and the allocation of decision rights become interlinked. This paper looks at this idea in the specific context of a principal's problem of inducing agents to provide unobservable effort while also motivating the efficient selection of investments. Each of these problems has been extensively studied in isolation (on inducing We thus know that motivating effort is done best by rewarding agents on precise measures of their effort, not necessarily on the total value created in the firm. At the same time, it is clear that getting the right investment choices may require that the decision makers' rewards be tied to total value