Repeated Games , Part III : Informal Authority in Organizations

Authority is the defining feature of hierarchy. The boss can restrict the subordinate’s actions, overturn his decisions, and even fire him (unless the boss’s boss objects, in which case the boss herself may be fired). Tracing this chain of authority up the hierarchy, we eventually reach a person (sole proprietor) or group (shareholders) who can be thought of as owning all the decision rights in the organization. In short, formal authority resides at the top. Of course, few organizations are run by tyrants who actively exercise their ownership of all the decision rights in the organization. To the contrary, many middle managers wield substantial authority. But we assert that such authority is always informal, in the sense that it can be retracted by those higher up the hierarchy, ultimately by those at the top who hold the formal authority. That is, we see all subordinates’ decision rights as loaned, not owned. Given that formal authority resides at the top of organizations, when and how will bosses delegate informal authority to subordinates? To begin to study these questions, we develop a simple model in which a subordinate develops a project to propose to a boss. The boss has the formal authority over whether to ratify the project (i.e., over whether to allow the project to be implemented), but the boss may informally delegate this ratification authority to the subordinate. We see this ratification decision as a metaphor for a wide range of decisions that might be informally delegated, including decisions about human resources (hiring, training, job design), decisions about production (sourcing, capital and operating expenditures), decisions about competition (pricing, advertising, product design), and so on. We analyze our model in two environments: in the first, the boss has the information necessary to assess the project before it is ratified; in the second, the boss does not have this information. For certain parameters in the “informed boss” model, the boss informally delegates authority by promising to ratify all projects that the subordinate proposes, even if they are not in the boss’s (or even the firm’s) best interest. If this promise is believed, it induces superior effort from the subordinate in the initiation stage (i.e., in searching for and