The separation of Decision Making and Risk Bearing: Organizational Form and the Decision to go Private

Ernst Maug
Duke University, Durham, NC 27708

ABSTRACT

This paper investigates the hypothesis that the separation of ownership and control is made viable by an organizational structure that separates decision making from monitoring. The paper analyses the choice of organizational form and contrasts a hierarchy where executive management is monitored and remunerated by a director who acts as a supervisory agent, and an entrepreneurial firm in which all control rights are concentrated in the hands of a single agent. It is shown how the organizational form affects the allocation and the tradeoff between risk-sharing and incentives. The model predicts that the hierarchy is a dominant choice if productive efforts are difficulty to monitor. Also, more efficient hierarchies have a lower correlation between shareholder value and managerial compensation. The paper sheds some light on the decision to go private and on the reverse-LBO phenomenon.