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The Effect of Organizational form on Information Flow and Decision Quality: Informational Cascades in Group Decision Making

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  • Steve L. Slezak
  • Naveen Khanna

Abstract

This paper identifies a disadvantage to decision making in a team. We show that in some cases available information is lost due to sequential communication that results in informational cascades. Although incentive contracts exist that prevent cascades, in some cases these contracts do not maximize shareholders' expected residual value and cascades are tolerated in equilibrium. Cascades never occur in hierarchies that exogenously prevent communication. However, when the firm is organized as a hierarchy (and the agents are given the optimal hierarchical contract), in some cases agents will collude and sequentially communicate, admitting the possibility of cascades. In these cases, the principals must monitor and enforce the hierarchical process. When monitoring costs exceed the cost of cascades, the team is the optimal organizational form. Copyright (c) 2000 Massachusetts Institute of Technology.

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  • Steve L. Slezak & Naveen Khanna, 2000. "The Effect of Organizational form on Information Flow and Decision Quality: Informational Cascades in Group Decision Making," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 9(1), pages 115-156, March.
  • Handle: RePEc:bla:jemstr:v:9:y:2000:i:1:p:115-156
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    Cited by:

    1. Pegaret Pichler, 2004. "Optimal Contracts for Teams of Money Managers," Econometric Society 2004 North American Winter Meetings 495, Econometric Society.

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