Discussion of Divisional versus Company-Wide Focus: The Trade-Off between Allocation of Managerial Attention and Screening of Talent

Abstract

Divisional versus Company-Wide Performance Measures: The TradeOff between Allocation of Managerial Attention and Screening of Talent examines the use of risky contracts as a screening mechanism in a population of differently abled potential managers. The authors examine two settings. In both settings a firm's owner writes a contract to hire a riskaverse, but not effort-averse, manager. The manager may have high or low talent, but the manager's type is not known to the owner at the time of contracting. In both settings the manager must make an effort allocation choice. While the allocation choice itself is not costly to the manager, the risk that the choice may impose on the manager can be. The owner in contracting uses the willingness of the manager to accept a risky contract to screen out the low-talent type. A separating contract offers an adequate risk premium to compensate high-talent managers, which is too low to cause low-talent candidates to impersonate high-talent candidates, given their alternative contract. Low-talent managers receive a flat wage, inadequate to cause high-talent candidates to forgo the risky contract, but strictly greater than the reservation utility of low-talent candidates. In the setting for which the paper is named, the firm has two divisions. Each division is represented by a stochastic binary outcome which depends on the manager's effort allocation and type. The manager must decide whether to focus all effort on his own division or allocate some fixed amount of effort to the other division as well. If the manager allocates