Milton and Karl: A Behavioral Model of Capitalist vs. Socialist Resource Allocation

The allocation of corporate resources is a central managerial lever in multi-business firms. But while fluidity in allocations is commonly considered to yield higher financial returns, empirical research has noted a tendency towards more stable, and often even equal, allocations. That is, weaker businesses receive more resources than their relative performance might suggest, while stronger businesses receive comparably less. This “socialist” allocation process is in stark contrast to a more “capitalist” process where allocations are strongly performance-dependent. In this paper, we take a behavioral perspective and ask: how do resource allocation patterns affect the adaptability of multi-business firms? We develop a computational model in which corporate headquarters allocates resources to business units, which use them to refine existing technologies or search for novel ones. Modeling the distribution of new technologies and their possible evolutionary trajectories allows us to develop a typology of stylized market segments in which business units may operate. We use this set-up to compare three resource allocation patterns: performance-based allocation, equal allocation, and inverse performance-based allocation. The analysis of our model suggests that each allocation pattern can be optimal under different conditions. Building on this baseline, we construct portfolios of business units that operate in different environments, and that are downstream competitors or exhibit complementary relationships. We find that competition between units often favors performance-based allocation. Integrating complementarities, however, produces varied results: for stable or more limited environments, performance-based allocation continues to dominate, whereas for more dynamic environments, fixed or inverse allocations become dominant.