The Roman Forum, the commercial, cultural, and political centre of the Republic (Source: Wikipedia Commons)
Ideas for Leaders #237

Centralized or Decentralized Decision Rights in Multinationals

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Key Concept

Certain company and country factors determine whether decisions should be centralized at parent company headquarters or decentralized to the foreign subsidiary. Ignoring those factors will hurt parent and subsidiary financial performance. And fixing the inappropriate decision-making structure could prove costly.

Idea Summary

A parent company can either centralize decision-making related to a foreign subsidiary at the parent company headquarters or decentralize those decisions to the subsidiary. Working with two decades worth of data from U.S. multinationals, Leslie Robinson and Phillip Stocken of the Tuck School of Business identified some key factors that determine which is the better choice.

At the subsidiary level, the following factors would favor centralized decision-making:

  • sourcing of goods from the U.S.
  • inter-company transactions with the parent
  • smaller subsidiaries
  • new subsidiaries

The following factors suggest decentralized decision-making:

  • idiosyncratic local demands
  • high local labor costs and financing activities
  • higher product diversity
  • larger subsidiaries

At the firm level, vertical integration and extensive parent company experience in the country of the subsidiary would suggest that centralization is a better option. On the other hand, the scale and scope of international business or the inexperience of the parent company in the foreign country would indicate that decentralized decision-making would be more effective.

Finally, at the country level, centralized decision-making is recommended for markets with an unstable business environment, as well as a culture of authority. If there is extensive market competition at the lower level, however, decentralization would be called for.

By comparing the above factors to the decision-rights allocation of the sample firms, they determined whether there was a mismatch between what the factors suggested would be the right choice on centralization or decentralization of decision-making and the actual choice of the firm.

Once they had located such mismatches in their data, Robinson and Stocken used performance results to see if there was a correlation. In other words, they sought to determine if a mismatch translated into poor firm performance.

The researchers also analyzed the data to see if or how companies fixed the problem of mismatches. Did they adjust the organizational structure to better fit the environments as defined by the factors listed above?

The results of their research show that firm performance is impacted by inappropriate decision-rights allocation. The impact is especially high when decisions are inappropriately decentralized.

Whether firms fix the problems, the research reveals, depends on whether the problem is a question of centralization or decentralization. Firms are willing to decentralize decision-making down to the foreign subsidiaries when decisions had been wrongly centralized. The reverse, however, is less common; firms are less likely to take back decision-making from a subsidiary. This is especially true if the subsidiary, despite the mis-allocation, is performing adequately; in this case, the costly medicine may not be worth the cure.

Business Application

Who makes the decisions is a vital issue for a firm with foreign subsidiaries. Managers must pay close attention to factors, such as vertical integration or high levels of competition in the foreign markets, that suggest whether centralization or decentralization of decision-making is the optimal organizational structure. The wrong structure, especially if decisions are inappropriately decentralized, can be very costly.

The research shows, in fact, that while inappropriately centralizing decisions can impact firm performance, decentralizing decisions down to subsidiaries when they should be centralized is a much greater mistake. Not only would the impact be greater on the bottom line, but it is also much more costly to reverse the mistake. Bringing decisions back to the parent company is not easy, and may involve renegotiation of employment contracts, restructuring the location of institutional knowledge, and adjusting accounting and internal control systems — not to mention the organizational political fallout.

The ultimate lesson is, therefore, that multinational firms must make their decision-rights allocations carefully, but must tread especially cautiously if they are ready to allow foreign subsidiaries to make the major decisions. 

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Authors

Institutions

Source

Idea conceived

  • July 2013

Idea posted

  • October 2013

DOI number

10.13007/237

Subject

Real Time Analytics