The Optimality of Delegation under Imperfect Commitment

Should a boss (principal) delegate authority (decision right) to his or her subordinate (agent) if the subordinate has private information? This paper answers this question under the “imperfect commitment” assumption that compensation schemes are contractable but decisions are not verifiable. Our conclusions are that (i) the allocation of authority is determined by a trade-off between a self-commitment cost due to centralization and an incentive cost due to delegation, (ii) and that the principal should adopt a performance-based compensation scheme under both delegation and centralization; however, the optimal compensation schemes are rather different. Furthermore, we find a new kind of advantage from delegation.