Discussion of Centralization, Delegation, and Shared Responsibility in the Assignment of Capital Investment Decision Rights

Baiman and Rajan use the joint forces of relationship-specific investment and incomplete contracting to model a principal's choice between a centralized organization, where he decides the level of investment in a capital asset, and a decentralized organization, where those decision rights are contractually assigned to the agent. When contract incompleteness prevents the principal from committing to a level of capital investment, his ex post incentive to underinvest in the capital asset causes an inefficient mix of capital and labor. The principal can eliminate the inefficiency resulting from his own opportunistic behavior by assigning the capital investment decision to the agent, but the agent will overinvest in the capital asset in order to reduce his personal cost of effort when he is given the decision rights. As a result, the principal's centralizationdelegation choice is essentially a choice between the inefficiency resulting from the principal's opportunistic underinvestment of capital and the inefficiency resulting from the agent's incentive to minimize his effort by overinvesting in capital. Some type of contract incompleteness is necessary for the organizational form to matter. Baiman and Rajan assume that the agent's compensation cannot depend on the realization of a state variable, 0, which determines the efficient mix of capital and labor. However, the agent