U Budget Cuts

As you probably know, the U's budget has been cut, and probably will be cut again. I'm on the U's "Salaries and Annuities" committee, and I attended a meeting yesterday with the committee and some high-up administrators.

Faculty salary cuts are being considered, depending on the size of the cut coming from the legislative session.

But what a great meeting!

The reason this was a great meeting is that I study labor markets, employment relationships, and how to structure decisions in organizations. And this meeting had all these issues.

(As an aside: Pretty much everything that has happened since September 17 has been bad for my portfolio and salary --- just like everyone else's. But for me it's been interesting professionally. In expressing my interest, I risk coming off like I'm enjoying this. I'm not --- and on top of that I know that a lot of people are hurting from job loss. I'd for sure undo it if I could.)

The U is facing a bunch of interesting decisions right now, and I'll probably blog about them over the next week or so. One decision is this: If the U needs to cut faculty salaries by X%, how should it do so? Here are a couple of options:
(1) Reduce every professor's salary by X%.
(2) Tell each college that its total salary amount has to fall by X%, but let the deans and department chairs determine how to achieve that goal.

Fundamentally, this question is one about delegation of decisions. It's about where we should put decision-making responsibility in this organization. Option (1) is central administration making the decision. Option (2) is central administration delegating the decision to the deans and department chairs, subject to some parameters. It's exactly the kind of issue we consider in Fin 6250.

So what are the economics of delegation?

As with everything in life, delegation involves tradeoffs. There are benefits and costs associated with delegation, and it's important to weigh them carefully.

On the benefit side, delegation often means you're better able to make use of local information. What does that mean in this context? As one example, deans and department chairs know best about the labor market conditions in their particular fields. Central administration doesn't know (at least, not as well as the deans and department chairs) which of the finance professors are highly sought after by other universities, and which are not. In cutting salaries, you're providing opportunities for rival employers to pick off your best faculty. Choosing option (2) allows deans and department chairs to be a bit strategic about any salary cuts. It allows them to make smaller cuts in cases where labor market competition is intense, and larger cuts where the competition isn't so intense. This is potentially beneficial, in that it might allow the U to do a better job of retaining faculty.

There are a couple of potential costs of delegation. The first is agency costs. Deans and department chairs might have different preferences from central administration. It's possible --- at least in principle --- that deans might not allocate scarce salary dollars in the way that central administration thinks is best for the university as a whole. The best example of this comes from thinking about across-department and across-school externalities. Suppose there's a math professor who spends a lot of time working with faculty and students from the school of engineering. The math department might not value this person so much, and might decide to focus salary resources elsewhere. If this person left, it might hurt the school of engineering, but the math department might not take that into account.

A second potential cost comes from coordination problems, but I'm hard pressed to come up with an example of this one in the context of university salary cuts. In Chapter 3 of the forthcoming fifth edition of my book Economics of Strategy, I write about coordination in military organizations. Delegating decisions to lower-level commanders in military operations is often not a good idea, because actions of different units need to be coordinated. Attacks might work best if all units attack at the same moment, and as a result delegating decisions might achieve the best outcome. One good example of coordination in for-profit firms comes from marketing campaigns --- it's sometimes best if a firm's various products are marketed using a consistent message. Delegating decisions to product-level marketing groups might fail to deliver that consistent message, and so it can be good to have centralized oversight of such choices.