Decentralization of the Firm: Theory and Evidence

Jensen and Meckling (1992) hypothesize that the firm's decentralization decision is determined by a tradeoff of knowledge transfer costs and control (agency) costs. To maximize value, either knowledge must be transferred to those with the right to make decisions or decision rights must be transferred to those who have the knowledge. We identify characteristics of firms' investment opportunity sets that affect knowledge transfer and control costs and generate testable predictions about the relations between these characteristics and firms' decentralization decisions. The evidence we present is generally consistent with our predictions and is robust to different ways of measuring variables