Abstract
An organization faces a stream of random events everyday. Whether to set managerial rules or allow managerial discretion is a key issue in organizations. In this paper, we investigate the boundaries between rules and discretion in authority. Using an incomplete contract approach, we differentiate between projects that are more efficiently managed under rules and those that are more efficiently managed under discretion. Our main finding is that for conservative projects with low expenditures and balanced expenditure to quality ratios, rules are more efficient than discretion; for other projects, discretion is efficient. We also find that rules offer better incentives; discretion works better for risky projects; whenever discretion is efficient, rules are equally efficient; and the income share of the manager is independent of her decision-making rights, i.e., separation of income and control rights.
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