Capital Allocation and Delegation of Decision-Making Authority within Firms

John R. Graham

Duke University; National Bureau of Economic Research (NBER)

Campbell R. Harvey

Duke University – Fuqua School of Business; National Bureau of Economic Research (NBER)

Manju Puri

Duke University – Fuqua School of Business; National Bureau of Economic Research (NBER)

Abstract:

We use a unique dataset of more than 1,000 Chief Executive Officers (CEOs) and Chief Financial Officers around the world to investigate the degree to which executives delegate financial decisions and the circumstances that drive variation in delegation. Delegation does not appear to be monolithic; instead, our results show that it varies across corporate policies and also varies with the personal characteristics of the CEO. We find that CEOs delegate decisions for which they need the most input and when they are overloaded. CEOs delegate financial decisions less when they are knowledgable (long-tenured or with a finance background). They delegate more when distracted by recent acquisitions, and they allocate capital based on “gut feel” and the personal reputation of the manager running a given division. Finally, corporate politics and corporate socialism affect capital allocation in European and Asian firms.

Capital Allocation Delegation of Decision

Capital Allocation and Delegation of Decision-Making Authority within Firms – introduction

An exciting new area of research looks inside the black box of the firm, to understand how corporate decisions are made and by whom. One branch of the organizational economics literature focuses on the delegation of decision-making authority (see Section 2 for a review). A basic framework involves a principal (the Chief Executive Officer (CEO) in our analysis) who needs information or effort from an agent (upper level management in our analysis). In order to benefit from employees’ information or proximity to certain activities, the CEO considers sharing control via delegating decision-making authority down the corporate ladder. The CEO could in principle gather the desired information but this self-gathering approach would become more costly to the CEO as the firm becomes very large or complex or as the CEO becomes overloaded (e.g., Aghion and Tirole, 1997). While the theoretical literature identifies many interesting trade-offs, the empirical evidence is scarce because [as noted by Prendergast (2002)] and others the econometrician can rarely observe the roles and responsibilities behind the corporate decision-making process, including how these vary across different decisions and settings.

Capital Allocation Delegation of Decision

We use a unique database of executive decision-making to study how CEOs and other high-level managers share the decision-making process related to five important corporate decisions: financing choices, returning capital to investors, mergers and acquisitions (M&A), corporate investment, and the allocation of capital across divisions. Our analysis relies on an anonymous survey-based sample of more than 1,000 CEOs and 500 CFOs who work in U.S.- based companies. In addition, we sample approximately 800 Asian and European executives. These business leaders provide information about their own backgrounds and training, demographic information about their firms, and the degree to which the five corporate finance policy decisions are delegated. In addition, we probe more deeply into decision rules associated with capital allocation.

Our data set has substantial variation across people, firms, divisions, industries, countries, and crucially, in the importance of informational inputs coming from different levels of the corporate hierarchy. This allows us to measure the degree of delegation in general, whether delegation varies across policies and settings, and to the extent that it varies, the factors that drive the variation. Our main findings can be grouped into the following themes.

First, we study whether delegation is company-wide; that is, invariant within the firm. We examine how the magnitude of delegation varies across the five key corporate policies, whether the sensitivity of delegation varies across policies and key drivers of those policies, and in particular, whether this variation is tied to the information requirements of the different policies. We also study interactions in delegation across policies.

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Capital Allocation Delegation of Decision

Capital Allocation Delegation of Decision