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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.

Suggested Citation

  • 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
    DOI: 10.1111/j.1430-9134.2000.00115.x
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    References listed on IDEAS

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    1. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn.
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    3. Raaj Kumar Sah, 1991. "Fallibility in Human Organizations and Political Systems," Journal of Economic Perspectives, American Economic Association, vol. 5(2), pages 67-88, Spring.
    4. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
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    6. McAfee, R Preston & McMillan, John, 1991. "Optimal Contracts for Teams," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(3), pages 561-577, August.
    7. HOLMSTROM, Bengt, 1979. "Moral hazard and observability," LIDAM Reprints CORE 379, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    8. Khanna, Naveen, 1998. "Optimal Contracting with Moral Hazard and Cascading," The Review of Financial Studies, Society for Financial Studies, vol. 11(3), pages 559-596.
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    Cited by:

    1. Renee B. Adams & Benjamin E. Hermalin & Michael S. Weisbach, 2010. "The Role of Boards of Directors in Corporate Governance: A Conceptual Framework and Survey," Journal of Economic Literature, American Economic Association, vol. 48(1), pages 58-107, March.
    2. David Hirshleifer & Siew Hong Teoh, 2003. "Herd Behaviour and Cascading in Capital Markets: a Review and Synthesis," European Financial Management, European Financial Management Association, vol. 9(1), pages 25-66, March.
    3. Pegaret Pichler, 2004. "Optimal Contracts for Teams of Money Managers," Econometric Society 2004 North American Winter Meetings 495, Econometric Society.

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