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On the Use of Hierarchies to Complete Contracts when Players Have Limited Abilities

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M. Martin Boyer ()

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Abstract

Why do larger corporations have more layers in their hierarchy? My contention in this paper is that hierarchies arise because economic agents have limited ability to anticipate and ascertain every possible contingency they are faced with. As a result, the complete contract may become too complex (or too costly) to devise and manage directly. My contention in this paper is that hierarchies may help a limited-ability principal (the organization's president) collect all pertinent information about the productive elements in the organization so that the complete is again possible. The contributions of the paper are six-fold: 1) it suggests a reason why hierarchies exist; 2) it develops a measure of the quantity of information that needs to be processed at each level of the organization; 3) it measures endogenously the optimal number of layers in a hierarchy given the players' ability to process information; 4) it provides a rationale for having the most talented individuals at the top of the hierarchy; 5) it offers an explanation for the existence of an unique president in an organization; and 6) it explains how the number of layers and of managers may vary over time as the company grows and/or the players' ability changes.

Dans cet article je m'intéresse à la raison pour laquelle les organisations publiques comme privées ont recours à une hiérarchie informationnelle. Je propose un modèle théorique qui explique l'existence des hiérarchies comme étant un outil nécessaire pour aider les agents à récolter le plus d'information possible étant donné leurs capacités limitées. Ainsi, à cause de cette limite intellectuelle et/ou computationnelle des agents économiques au sein des organisations, le contrat complet est trop complexe pour être mis en oeuvre dans les organisations à moins d'utiliser une structure pyramidale pour gérer l'information. En fait, les hiérarchies permettent de récolter plus d'informations à moindre coût. Les contributions de l'article sont les suivantes: 1) il suggère une raison à l'existence des hiérarchies; 2) il développe une mesure de la quantité d'information qui doit être gérée au sein d'une organisation; 3) il mesure de manière endogène le nombre optimal de niveaux au sein de la hiérarchie organisationnelle étant donné les capacités limitées des agents; 4) il rationalise le fait d'avoir les individus les plus talentueux au haut de la pyramide; 5) il donne une explication au fait d’avoir un seul président dans l'organisation; et 6) il explique comment le nombre de niveaux et le nombre de gestionnaires varient lorsque l'entreprise grandit ou lorsque les tâches des agents changent.

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Paper provided by CIRANO in its series CIRANO Working Papers with number 2004s-41.

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Date of creation: 01 Aug 2004
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Handle: RePEc:cir:cirwor:2004s-41

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Related research
Keywords: hierarchies; contract theory; complexity; correlated information; hiérarchies; théorie des contrats; complexité; information corrélée;

Find related papers by JEL classification:
L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information

This paper has been announced in the following NEP Reports:

References listed on IDEAS
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