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On The (Sub) Optimality Of Multi-Tier Hierarchies: Coordination Versus Motivation

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Chongwoo Choe
Shingo Ishiguro

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Abstract

This paper studies internal organization of a firm using an incomplete contracting approach `a la Grossman-Hart-Moore and Aghion-Tirole. The two key ingredients of our model are externalities among tasks that require coordination, and investment in task-specific human capital. We compare three types of organizational structures: centralization where the decision authority for all tasks is given to the party without task-specific human capital, decentralization where the decision authority for each task is given to the party with necessary human capital, and hierarchical delegation where the decision authority is allocated in a hierarchical fashion. Centralization is optimal when externalities and the requisite coordination are the main issue in organization design. Decentralization is optimal if the investment in human capital is more important. Hierarchical delegation is optimal in the intermediate case. We also discuss the optimal pattern of hierarchical delegation as well as several directions extending the basic model.

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Paper provided by Monash University, Department of Economics in its series Monash Economics Working Papers with number 18/08.

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Length: 43 pages
Date of creation: 01 Jul 2009
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Handle: RePEc:mos:moswps:2008-18

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Related research
Keywords: Delegation; Incomplete Contracts; Hierarchy;

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Find related papers by JEL classification:
C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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