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Managerial Leverage is Limited By the Extent of the Market: Hierarchies, Specialization and the Utilization of Lawyers' Human Capital

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  • Garicano, Luis
  • Hubbard, Thomas

Abstract

This paper examines hierarchies’ role in the organization of human-capital-intensive production. We develop an equilibrium model of hierarchical organization, then provide empirical evidence using confidential data on thousands of law offices from the 1992 Census of Services. We show how the equilibrium assignment of individuals to hierarchical positions varies with the degree to which their human capital is field-specialized; then show how this equilibrium changes with the extent of the market. When the extent of the market increases, individuals’ knowledge becomes narrower, but deeper. Managerial leverage, the number of workers per manager, optimally increases to exploit this depth. We find empirical evidence consistent with a central proposition of the model: the share of lawyers that work in hierarchies and the ratio of associates to partners increases as market size increases and lawyers field-specialize. Other results provide evidence against alternative interpretations that emphasize unobserved differences in the distribution of demand or ‘firm size effects’, and lend additional support to the view that a role hierarchies play in legal services is to help exploit increasing returns associated with the utilization of human capital.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4924.

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Date of creation: Feb 2005
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Handle: RePEc:cpr:ceprdp:4924

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Keywords: division of labour; hierarchy; industry structure; organization; specialization;

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  1. Van Zandt, Timothy, 1999. "Real-Time Decentralized Information Processing as a Model of Organizations with Boundedly Rational Agents," Review of Economic Studies, Wiley Blackwell, vol. 66(3), pages 633-58, July.
  2. Radner, Roy, 1993. "The Organization of Decentralized Information Processing," Econometrica, Econometric Society, vol. 61(5), pages 1109-46, September.
  3. Raghuram G. Rajan & Luigi Zingales, 1997. "Power in a Theory of the Firm," NBER Working Papers 6274, National Bureau of Economic Research, Inc.
  4. Sherwin Rosen, 1982. "Authority, Control, and the Distribution of Earnings," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 311-323, Autumn.
  5. Raghuram G. Rajan & Julie Wulf, 2006. "The Flattening Firm: Evidence from Panel Data on the Changing Nature of Corporate Hierarchies," The Review of Economics and Statistics, MIT Press, vol. 88(4), pages 759-773, November.
  6. Roy RADNER & Timothy VAN ZANDT, 1992. "Information Processing in Firms and Returns to Scale," Annales d'Economie et de Statistique, ENSAE, issue 25-26, pages 265-298.
  7. Paul M Romer, 1999. "Increasing Returns and Long-Run Growth," Levine's Working Paper Archive 2232, David K. Levine.
  8. Rebitzer, James B, 1993. "Radical Political Economy and the Economics of Labor Markets," Journal of Economic Literature, American Economic Association, vol. 31(3), pages 1394-434, September.
  9. Qian, Yingyi, 1994. "Incentives and Loss of Control in an Optimal Hierarchy," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 527-44, July.
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