Managerial Delegation, Law Enforcement, and Aggregate Productivity

This paper proposes a novel conceptual framework to quantify how law enforcement shapes the internal organization of firms and thereby aggregate equilibrium outcomes. First, we present empirical evidence on a signifiant positive cross-country correlation between the aggregate share of managerial workers and the degree of law enforcement. Second, we construct a tractable model that captures benefits to managerial delegation in large organizations. The model features an agency problem between the owner of the firm and its middle managers. Ineffective law enforcement, allowing middle managers to divert revenue from the firm, constrains firm size by limiting the efficient delegation of managerial authority as well as managerial employment. Third, a calibrated version of the model measures the effect of deteriorating legal protection. Decreasing law enforcement from the U.S. benchmark to a level associated with countries at ten percent of U.S. GDP per capita reduces aggregate productivity by 18 percent. Auxiliary statistics on the mean employer business size, self-employment, productivity dispersion, skill premium and human capital all paint a picture characteristic of low-income countries.