Delegation of Authority, Managerial Initiatives, and the Design of Divisional Structure

This paper provides a rationale for a firm to adopt either an integrated or a separated divisional structure, which is based on the interplay between the structure of authority and the costs and benefits of integration vis-a-vis separation. We use the framework of Aghion and Tirole (1997) to explain the structure of authority. This framework captures the notion of managerial initiatives. It shows that monitoring by the head office decreases divisional managers' effort levels. We incoporate this framework into the analysis of costs and benefits of integrating or separating divisions. Integration will be beneficial for the head office if it generates synergy gains. The larger the synergy gains are, the more appealing integration will be. Consequently, the head-office's incentive to monitor increases. Due to a more intense monitoring, managers exert lower effort levels. For managers, integration entails costs and benefits. If the benefits outweigh the costs, managers will be motivated to exert high effort levels in an integrated divisional structure. The optimality of integrating or separating divisions will then be determined by the trade-off between synergy gains and the managerial effort elicitation.