Working Paper: CEPR ID: DP15602
Authors: Gyngyi Loranth; Alan Morrison; Jing Zeng
Abstract: We show that a firm can use its organizational structure to commit to an investment strategy. The firmdelegates sequential search and project management tasks to a manager. Ex post, the firm turns away projects that generate high project management rent. However, because the expectation of such rent serves to defray the manager’s search cost, investment might be optimal ex ante. A leveraged subsidiary mitigates this time-inconsistency problem by creating ex post risk-shifting incentives that counteract underinvestment. Subsidiaries are more valuable for projects with costly search, intermediate management costs, and returns that are uncorrelated with the existing business.
Keywords: organizational structure; multinational business; branch; subsidiary
JEL Codes: G32; G34; L22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Organizational Structure (Branch vs. Subsidiary) (L22) | Investment Strategy (Acceptance of projects) (G11) |
| Search Costs (D40) | Investment Decision (G11) |
| Project Management Costs (O22) | Investment Decision (G11) |
| Investment Decision (G11) | Value of Commitment (D46) |
| Magnitude of Managerial Search Costs (M51) | Choice of Subsidiary Structure (L22) |
| Competitive Environments (L13) | Formation of Subsidiaries (L22) |