An Agency Theory of the Division of Managerial Labor

Should responsibility for strategic planning and execution be assigned to the same manager? Should a firm have a Chief Operating Officer with responsibilities distinct from those of the Chief Executive Officer? How does the division of labor affect managerial opportunism? This paper uses a formal agency-theoretic model to address these questions and present a new theory of the division of managerial labor. Building on Penrose's typology, the theory identifies when to assign (i) entrepreneurial services, which relate to strategic planning and the acquisition of resources, and (ii) managerial services, which relate to execution, to the same generalist manager rather than to different specialists. The analysis reveals the critical importance of separability, i.e., whether a supervisor can separately observe the outcomes of entrepreneurial and managerial services. If managers and their supervisor have symmetric information about separability, hiring a generalist dominates because managerial services, which are easier to assess, reduce the scope for opportunism associated with entrepreneurial services, which are harder to assess. Conversely, if managers have better information regarding separability and the probability of separability is low, hiring specialists dominates because hiring a generalist allows the potential for opportunism associated with entrepreneurial services to contaminate the provision of managerial services. Even so, the benefits of hiring a generalist may be restored if the services are sequenced appropriately. An implication of such sequencing is that a firm will grow in fits and starts, giving rise to a "Penrose effect" even if labor market frictions do not impede the assimilation of new managers.