Lack of Selection and Limits to Delegation: Firm Dynamics in Developing Countries

Abstract

Delegating managerial tasks is essential for firm growth. Most firms in developing countries, however, do not hire outside managers but instead rely on family members. In this paper, we ask if this lack of managerial delegation can explain why firms in poor countries are small and whether it has important aggregate consequences. We construct a model of firm growth where entrepreneurs have a fixed time endowment to run their daily operations. As firms grow large, the need to hire outside managers increases. Firms’ willingness to expand therefore depends on the ease with which delegation can take place. We calibrate the model to plant-level data from the United States and India. We identify the key parameters of our theory by targeting the experimental evidence on the effect of managerial practices on firm performance from Bloom et al. (2013). We find that inefficiencies in the delegation environment account for 11 percent of the income per capita difference between the United States and India. They also contribute to the small size of Indian producers, but would cause substantially more harm for US firms. The reason is that US firms are larger on average and managerial delegation is especially valuable for large firms, thus making delegation efficiency and other factors affecting firm growth complements. (JEL D22, G32, L25, L26, O14)