A Theory of Capital Structure with Strategic Defaults and Priority Violations

Why do firms delegate job design decisions to workers and what are the implications of such delegation? We develop a private-information based theory of delegation where delegation provides a more efficient allocation of talent inside the firm, but at the cost that low ability workers must be compensated to self-sort. Career concerns limit the effectiveness of delegation: when returns to ability or market observability of job content are high, the compensation needed to get low-ability workers to self-sort is high, and firms limit delegation to avoid cream-skimming of the high-ability workers. We investigate implications for how misallocation of talent within firms may occur, the optimal design of incentive contracts, and which decisions are more likely to be delegated to subordinates.