Introduction Many organizations use decision rules to

alleviate incentive problems as opposed to incentive contracts

The principal typically retains some decision making authority and partially delegates decisions to the agent

Recent work has examined the costs and the benefits of delegation versus centralization

Introduction The literature contains three

approaches:1. How does centralization affect the

agents gathering of information? (AT) 2. How does centralization affect the

agent’s transfer of information? (GK, MM, HR, D)

3. How does centralization affect the agent’s implementation of tasks? (Z)

Our Focus This paper will focus on one primary example of a

shared decision rule, namely the veto rule. We will compare this to complete delegation.

The manager will have private information about project quality and a proclivity to spend more than the principal, due to private benefits of spending.

Delegation has the advantage that the manager never has an inventive to distort information. However, it has the disadvantage of allowing the manager to take on undesirable projects.

Veto power in the hands of the principal will induce the agent to distort his private information, but will allow the principal to shut down undesirable projects.

Our Focus Does one of these decision rules dominate the

other? Dessein (2002) says yes. In fact, for reasonable

preference differences between the principal and the agent, delegation is superior. More precisely he says that delegation dominates veto unless the divergence in preferences is so large that informative communication is not possible.

This conclusion is unsettling due to the prevalent use of veto in real world organizations.

Our Focus We show that this result is tied to the

setup of the Dessein model as opposed to being a fundamental relationship between delegation and approval.

Dessein adopts the CS model and assumes a fixed difference between the optimal scale of the agent versus the principal for all project types. This rules out a beneficial pooling region under veto. This region is likely to be present in may real world firms. He also assumes a uniform distribution.

Our key points In our model, project type is project

quality and types are ordered from lowest to highest.

The agent wants to operate each project at a higher scale than would the principal due to private benefits of spending.

A perfectly informed principal would like to shut down an interval of the lowest quality projects, but an agent with complete decision rights would want to operate these at positive scales.

Key points Approval can have an advantage over

delegation because it induces agents observing low quality projects to pool at zero scale, as opposed to operating their low quality projects at a positive scale and generating losses for the principal.

If the probability distribution on types places enough mass on such types, we show that veto can dominate delegation for all feasible divergence parameters.

Key points Intuitively, veto is better when it results

in the rejection of low quality projects which have relatively high likelihood.

Features of our model:1. Single peaked preferences2. Multiplicative hidden info variable

representing project quality3. General continuous pdf4. Equilibrium concept: Perfect Bayesian

equilibrium satisfying the intuitive criterion.

The Model Consider a firm with a principal and a

single agent. The agent evaluates whether to take on

potential projects and makes spending proposals for those projects.

A project has a quality level denoted θ. The agent learns θ, but this can not be

verified by a third party. The principal only knows the probability distribution of θ.

Model

We assume the following about θ.

Model The principal’s utility function and the

agent’s utility function are, respectively (0 < α < c)

Model The agent derives too much utility

from spending. The divergence parameter is α.

The function f satisfies

Model The principal's optimal scale, given by

x*(θ), is the solution to

Model The agent’s optimal scale, given by

x(θ,α), is the solution to

Model In the following assumption we generate

the result that the agent would want to implement a positive scale with the lowest quality project, but the principal would shut this project down.

Decision Processes: Delegation and Veto

Delegation

Delegation

Our first result is described in

Delegation

Lemma 1 assumes that the degree of risk aversion is non-decreasing

Moreover, it essentially says that the smallest θ is not too small.

Under these assumptions our benchmark function is well behaved and the PBE is simple to describe.

Delegation We assume

Veto

Veto Under the veto rule, there can be

multiple equilibria, but each exhibits certain regularities.

Consider θ1 and θ2 such that the following three conditions are met, where we define θo as

Veto: Conditions on θ1 and θ2

Veto: Illustration

Equilibrium Proposal

Characterization of PBE: Two Lemmata

Some Facts The equilibrium outlined above is shown

to exist. That is, there are θ1 and θ2 such that the above conditions are met. This fact is shown in the text.

However there is a continuum of such equilibria and we need a selection device.

I choose θ1 and θ2 so as to maximize the principal’s expected welfare under veto.

Selection of a unique PBE Use the implicit definition of θi to write θ1

as a function of θ2. Then we optimize the principal’s welfare over θ2.

The main result

Conclusion We provide a simple model of a principal and an agent in an

organization where two alternative decision processes can be used: delegation and veto.

We show that for any feasible magnitude of the difference in preferences between the principal and the agent, there is no clear-cut ranking of delegation and veto.

Approval has the advantage of shutting down low quality projects which if operated will cause losses for the principal, whereas delegation will result in all of these projects being operated at a positive scale. Delegation has the advantage over veto because it avoids the problem of marginal types mimicking the behavior of acceptable types and, in doing so, scaling their proposals beyond their own private optima.

Approval is most useful when lower quality projects are relatively more likely to be undertaken by a manager with decision making authority.