Capital Allocation and Delegation of Decision-Making Authority

This post comes to us from John Graham, Professor of Finance at Duke University, Campbell Harvey, Professor of International Business at Duke University, and Manju Puri, Professor of Finance at Duke University.

In our paper Capital Allocation and Delegation of Decision-Making Authority within Firms, which was recently published on SSRN, we examine the allocation of capital and the delegation of decision-making authority within firms. Theoretical research examines how decision-making authority is delegated within groups. While the theoretical implications are far-ranging, there is a scarcity of empirical evidence about the delegation of authority within corporations (as noted by Prendergast (2002) and others). This paper provides some of the first empirical evidence that focuses on the delegation of decision-making authority with respect to major corporate policies. In particular, we study whether the chief executive makes decisions on her own versus delegating to lower-level executives and divisional managers.

We survey more than 1,000 CEOs and CFOs around the world to determine who within the firm makes five different corporate decisions: capital allocation, capital structure, investment, mergers and acquisitions, and payout. Most of our analysis focuses on the 950 CEO and 525 CFO survey respondents who work in U.S.-based companies, though we also examine smaller samples of Asian and European executives. Knowing the job title of the corporate decision-maker is important, given recent evidence that executive-specific fixed effects appear to drive some corporate policies.

Our empirical evidence partially supports the theoretical predictions about which corporate policies CEOs should make in relative isolation with little delegation to lower level employees, and under which conditions. Theory predicts that CEOs should delegate more when their workload is high, and less when the CEO‟s knowledge is particularly valuable. The empirical evidence is consistent with these predictions. We also report that CEOs dominate merger and acquisition decisions (more so than CEO dominance of other policies), again consistent with theoretical implications. We document that CEOs delegate less when their pay is incentive-based, when they have MBA degrees, and when they have a background in finance or accounting. In terms of capital allocation across a given firm’s divisions, we find that CEOs rely on a NPV ranking of the various projects, which is consistent with textbook recommendations. We also find evidence that other factors importantly affect capital allocation, including the divisional manager’s reputation, the timing of when cash flows are produced by a project (which may matter due to financial constraints), and senior management’s “gut feel.” Interestingly, in the eyes of CFOs, internal corporate politics are believed to affect capital allocation, more so than in the eyes of CEOs. Finally, corporate socialism (that is, even distribution of capital across divisions) and corporate politics are more important in Europe and Asia than they are in the United States.

We believe that our study provides unique information about how decisions are made within firms, as well as how capital is allocated. We hope that researchers will use our results to develop new theories or potentially modify existing views.

The full paper is available for download here.

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