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January 17, 2023

Delegating authority

How does the need for coordination affect organization design?

Tyler Smith

Source: Prathan

Every large company must decide how much authority to give its managers. And economists would like to know why some companies delegate more power than others. 

Demand uncertainty is generally considered to be the central driver of this organizational choice. Locations with greater variability provide lower-level managers—those close to the facts on the ground—with greater empowerment to make decisions.

But, in a paper in the American Economic Journal: Microeconomics, authors Wouter Dessein, Desmond (Ho-Fu) Lo, and Chieko Minami show that if coordination within a business is crucial to success, centralization will actually be higher when local volatility is high.

Their results come from a fine-grained survey of a large general merchandise chain in Tokyo, whose identity was kept confidential. The information included the personal characteristics, job descriptions, and sales of just under 170 low- to mid-level managers, who oversaw departments such as kids apparel, clothing and accessories, cosmetics, home furnishing, groceries, and fish. While each department focused on a distinct product or service, they frequently coordinated with other departments on sales, pricing, marketing, merchandise, and customer service. 

Panel A of Figure 3 from the authors’ paper illustrates their main finding on the interaction between the need for coordination within the company and the amount of department volatility.

Panel A of Figure 3 from Dessein et al. (2022)

The upward-sloping gray line in the chart shows the amount of task delegation when the need for coordination was low (tenth percentile). In this case, an increase in unpredictability of customer demand from low to high increases delegation by about 28 percent. On the other hand, the downward-sloping dashed black line shows the amount of task delegation when the need for coordination is high (ninetieth percentile). In this case, an increase in demand uncertainty from low to high decreases delegation by roughly 10 percent.

The authors’ results indicate that when the need for coordination is low, lower-level managers are in the best position to adapt to business uncertainty, which favors decentralization. In contrast, when the need for coordination is high, higher-level management is better at coordinating tasks across departments in response to business volatility, which favors centralization.