Managerial Performance Evaluation and Organizational Form

We study the relative efficiency of centralized vs. decentralized organizational forms given optimized managerial performance evaluation within an incomplete contracting framework with risk-averse agents under moral hazard. Decentralization and performance evaluation are complementary control choices and the efficiency of an organizational form depends on the design of performance evaluation. Divisions can make relationship-specific investments that improve firm performance, but also increase compensation risk. We find that pure divisional performance evaluation is optimal under centralization, whereas under decentralization, opti- mal compensation contracts include a combination of divisional and firm-wide performance evaluation. When comparing both organizational forms, we find that the optimal form de- pends on managers’ degree of risk-aversion and the uncertainty of the business environment. Contrary to previous literature, we find that centralization dominates in many situations, par- ticularly at high degrees of risk-aversion and high uncertainty