Firm Hierarchy and the Market for Knowledge

This paper sheds light on the role of the market for knowledge in shaping a firm's hierarchy—that is, the span of control and the number of layers. We predict that the larger the extent of the market for knowledge, the larger the span of control and the fewer the layers. We test our predictions using a rich database representing industrial firms in Italy over the period 2004–2017. Our identification strategy employs a difference‐in‐difference approach that exploits the cross‐regional variability in the extent of the local market for knowledge‐intensive business services and the cross‐industry heterogeneity in the level of technological exposure of industrial firms to such a market. We find that a thicker regional market for knowledge is associated with relatively flatter firms in industries that use knowledge‐intensive business services more intensively. The results are confirmed when we use instrumental variables for the extent of the market for knowledge, test the sensitivity of the estimates to omitted variable bias, and perform a series of robustness checks.