by Milton Harris and Artur Raviv - Faculty

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projects, as middle management salaries increase, the organization design will change from the matrix form to a decentralized flat structure, possibly passing through a hierarchical structure. Note, however, in testing such implications, it is important to control for changes in the other parameters. In particular, it is likely that when salaries increase so do the benefits provided by middle managers, presenting a difficult identification problem. 7 Conclusions This paper attempts to explain organization structure based on optimal coordination of interactions among activities. The main idea is that each middle manager is capable of detecting and coordinating interactions only within his limited area of expertise. Only the CEO can coordinate company-wide interactions. The optimal design of the organization trades off the costs and benefits of various configurations of managers. The model provides a number of empirical predictions regarding firms’ organization design. In obtaining these results, we made a number of simplifying assumptions. Perhaps the most important of these is that middle managers have no opportunity cost of coordinating interactions. This assumption allows us to ignore a large number of solutions that would be optimal for various levels of this opportunity cost. Since these solutions are rarely observed in practice, we believe that ignoring the opportunity cost of middle managers is justified. A more important abstraction embedded in the model is the absence of incentive problems. These introduce a large set of considerations revolving around providing incentives to transfer information truthfully across managers within the organization structure. In particular, centralization of decisions will, no doubt, be more costly in such situations. This will bias the organization design toward flatter structures. D:\Userdata\Research\Hierarchies\temp.wpd 31 February 22, 2000 (11:18AM)
References Baron, David P. and David Besanko (1997), “Shared Incentive Authority and the Organization of the Firm,” Working Paper, Northwestern University. Blau, Peter M. and Richard A. Schoenherr (1971), The Structure of Organizations (New York: Basic Books). Bolton, Patrick and Mathias Dewatripont (1994), “The Firm as a Communication Network,” Quarterly Journal of Economics, CIX, 809-839. Calvo, Guillermo A. and Stanislaw Wellisz (1979), “Hierarchy, Ability, and Income Distribution,” Journal of Political Economy, 87, 991-1010. Child, John (1973), “Predicting and understanding organization structure,” Administrative Science Quarterly, 18, 168-185. Donaldson, Lex and Malcolm Warner (1974), “Structure of organizations in occupational interest associations,” Human Relations, 27, 721-738. Garicano, Luis (1997), “A Theory of Knowledge-Based Hierarchies,” University of Chicago Graduate School of Business Working Paper. Hart, Oliver and John Moore (1999), “On the design of hierarchies: Coordination versus specialization,” working paper, Harvard University Department of Economics. Hinings, Christopher R. and Gloria L. Lee (1971), “Dimensions of organization structure and their context: a replication,” Sociology, 5, 83-93. Jennergren, L. Peter (1981), “Decentralization in organizations,” in Handbook of Organizational Design, Paul C. Nystrom and William H. Starbuck, eds. (New York: Oxford University Press). Khandwalla, Pradip N. (1974), “Mass orientation of operations technology and organizational structure,” Administrative Science Quarterly, 19, 74-97. Pugh, Derek S., Hickson, David J., Hinings, Christopher R., Macdonald, Keith M., Turner, Christopher, and Tom Lupton (1968), “Dimensions of organization structure,” Administrative Science Quarterly, 13, 65-105. Qian, Yingyi (1994), “Incentives and Loss of Control in an Optimal Hierarchy,” The Review of Economic Studies, 61, 527-544. Radner, Roy (1993), “The Organization of Decentralized Information Processing,” Econometrica, 61, 1109-1146. Robbins, Stephen P. (1990), Organization Theory: Structure, Design and Applications, 3rd Edition (Englewood Cliffs, NJ: Prentice Hall). Sah, Raaj Kumar and Joseph E. Stiglitz (1986), “The Architecture of Economic Systems: Hierarchies and Polyarchies,” The American Economic Review, 76, 716-727. Singh, Nirvikar (1985), “Monitoring and Hierarchies: the Marginal Value of Information In a Principal-agent Model,” Journal of Political Economy, 93, 599-609. Vayanos, Dimitri (1997), “Optimal Decentralization of Information Processing in the Presence of D:\Userdata\Research\Hierarchies\temp.wpd 32 February 22, 2000 (11:18AM)
Page 1 and 2: ORGANIZATION DESIGN by Milton Harri
Page 3 and 4: eports both to the Project A divisi
Page 5 and 6: CEO President, ABC Norway President
Page 7 and 8: paid if the manager is available to
Page 9 and 10: information at the same time. Delay
Page 11 and 12: (1971), Khandwalla (1974) and Pugh
Page 13 and 14: managers who can discover and coord
Page 15 and 16: order and in which contingencies th
Page 17 and 18: value of the R-hierarchy (net of fi
Page 19 and 20: it is still optimal to use the CEO
Page 21 and 22: hierarchy is that the firm need pay
Page 23 and 24: 5 Comparative Statics For Q Optimal
Page 25 and 26: Figure 5: Optimal Organization Desi
Page 27 and 28: intermediate values of F, the centr
Page 29 and 30: appendix. Proposition 4. Increases
Page 31: divisional hierarchy. Next we exami
Page 35 and 36: Recall A(Q) Q(1 p 2 r 2 ) D G Q, B
Page 37 and 38: Similarly, for Q < 2r+r 2 s, K pr(Q
Page 39 and 40: is impossible. Therefore, Q B(p,r)
Page 41 and 42: Case 2: G > Q B(r,p) J and Figure 6
Page 43 and 44: and H(Q) L(Q) A(Q), for Q Q B (r,p)
Page 45 and 46: Case 6: J > Q B(r,p), J > G > Q B(p
Page 47 and 48: L(Q) A(Q), for Q Q B (p,r), C pr (Q
Page 49: for X = M, CP, CR, and CF implies t

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