Delegation versus an approval process and the demand for talent

In many organizations, a principal uses simple decision rules or decision processes, as opposed to complete contingent monetary contracts, to regulate a more informed agent's behavior. This paper models two such rules: delegation and an approval process. We determine the principal's preferable rule under different conditions and characterize the optimal demand for talent. In addition, we describe the agent's expected welfare under these rules and characterize how different talent might sort into the rules. If the decision process is not a choice or if the principal chooses approval for private gain, the demand for talent can be tied to the magnitude of loss in the worst state, rather than the degree of discretion given to the manager. However, if the principal has discretion over the decision process and proper incentives, then more talent is demanded under delegation. (c) 2005 Elsevier B.V. All rights reserved.