We thank Qi Chen, Shane Dikolli, Ken Hendricks, an anonymous referee, and workshop participants at The University of Texas at Austin, Northwestern University, University of California, Berkeley, and Carnegie Mellon University for helpful comments.
Delegation to Encourage Communication of Problems
Article first published online: 9 APR 2009
©, University of Chicago on behalf of the Accounting Research Center, 2009
Journal of Accounting Research
Volume 47, Issue 4, pages 911–942, September 2009
How to Cite
NEWMAN, D. P. and NOVOSELOV, K. E. (2009), Delegation to Encourage Communication of Problems. Journal of Accounting Research, 47: 911–942. doi: 10.1111/j.1475-679X.2009.00339.x
- Issue published online: 16 JUL 2009
- Article first published online: 9 APR 2009
- Received 13 November 2008; accepted 12 March 2009
We study a principal's choice to centralize or delegate decisions to an agent when delegation can be used to encourage the agent to communicate potential problems. We find that the principal may choose centralization either to exercise better control over the agent's actions or to provide stronger incentives. Delegation emerges in equilibrium only if the costs of effort to acquire information for both the principal and the agent are sufficiently high. We find that increases in the principal's penalties for an incorrect decision may increase the principal's expected payoff, owing to optimal organizational responses. In addition, catastrophic risk, the risk of incorrectly accepting a defective audit (or product), may be greater under centralization than under delegation. Furthermore, catastrophic risk can be increased by well-intentioned legislative efforts to decrease such risk by, for example, increasing the agent's penalties for failing to take a corrective action, because the organizational structure may change.