Centralize or Decentralize? How Productivity Shocks Affect Authority in Organizations

Abstract

This paper identifies how productivity shocks propagate within a multi-divisional organization and induce organizational change. Key ingredients are the presence of cross-divisional spillovers, background uncertainty associated with technology choices, and local information about the riskiness of innovation. When authority is decentralized and spillovers are small, a shock that increases the productivity gap across divisions increases the relative performance of centralization over decentralization and can lead the organization to centralize authority. Centralization: i) helps to curb the innovative ambitions of the manager of the most productive division, which hurt spillovers; and ii) improves communication within the organization when communication is most needed.