Process‐ Versus Function‐Based Hierarchies

I consider a firm's choice between having people who carry out complementary tasks report to the same manager and having them report to separate, function‐based managers. Even supposing that the former enhances coordination, the latter may be preferred because it improves the firm's control over employees. I show that, because switching from a function‐based hierarchy to a process‐based hierarchy reduces the firm's direct control, it raises the attractiveness of making the employee pay more sensitive to performance. Also, this switch tends to raise the profitability of fostering altruism between employees. I extend the analysis so that it deals with the relative benefits of IT‐ and M‐form organizations. I show that the M form becomes more profitable as the firm gets large.