The optimal allocation of decision and exit rights in organizations

Abstract

We show that in a bilateral relation with conflicting preferences and transferable utility it is unambiguously optimal to assign the authority over project decisions to the privately informed rather than the uninformed party. This holds irrespective of the degree of conflict and the distribution of private information. Under the optimal contract, the uninformed party is protected by an exit option, which it will exert when the decision maker has not chosen the promised decision. Exit terminates the relation and diminishes the project surplus. We show that the first‐best efficient solution can be obtained by such a contract.