Centralization versus Decentralization: An Application to Pricing by a Multi-Market Firm

This paper compares centralized and decentralized price setting by a firm that sells a single product in two markets, but is constrained to set one price (e.g. due to arbitrage). Each market is characterized by a different linear demand function, and demand conditions are privately observed by a local manager. This manager only cares about profits in his own market and, as a result, com-municates his information strategically. Our main results link organizational design to market demand. First, if pricing is decentralized, it is always dele-gated to the manager who faces the flattest inverse demand function, regardless of the size of market demand. Second, even when pricing can be allocated to an unbiased headquarters, decentralization is optimal when markets differ suf-ficiently in how flat the inverse demand functions are. Finally, decentralization is more likely when, in expectations, local managers disagree more about prices. ∗This paper was prepared for the invited session on "Decision-Making and Incentives in Orga-nizations " at the EEA 2007 Meeting in Budapest.