Centralization versus decentralization as a risk-return trade-off

This paper characterizes the choice between centralization and decentralization as a risk‐return trade‐off and examines it in a model that integrates ideas from committee decision‐making and portfolio theories. Centralization, by pooling expertise, rarely yields erroneous decisions; however, when it fails, the consequences are global. In contrast, in a decentralized system, erroneous decisions are more frequent, but their consequences are locally confined. We assess the relative desirability of (de‐)centralization in various scenarios with independent versus interdependent risks. We further discuss the robustness of the model and the relevance of our results for policymaking.