Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 131: Diversification and Delegation in Firms

Vittoria Cerasi () and Sonja Daltung ()
Additional contact information
Vittoria Cerasi: Dipartimento di Statistica, Postal: Università degli Studi di Milano Bicocca, Via Bicocca degli Arcimboldi 8, 201 26 Milano, Italy
Sonja Daltung: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Abstract: This paper is about the corporate structure, the organizational structure, and the financial structure of firms, and how they relate to each other. We show that separation of ownership and control may arise as a response to overload costs, although it involves agency costs, and that conglomerates can arise due to information problems in capital markets. In a context where entrepreneurs have the ability to run projects and to improve their future cash flow, there could be rationing of credit due to moral hazard between the entrepreneur and external investors. Diversification could mitigate the moral hazard problem. However for a single entrepreneur the running of many different projects might be increasingly costly due to overload, that is when, due to limited attention, the marginal effort becomes less effective. Delegating the running of projects to several managers can not only reduce overload costs, but also reduce the moral hazard problem of external financing. In this paper we show that delegation can be the only way to exploit gains from diversification when overload costs of diversification are high; delegation thus is the key ingredient to be able to diversify.

Keywords: Conglomerates; Delegation; Diversification; Monitoring

JEL-codes: D23; D82; G20; G32; L22

33 pages, December 1, 2001

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