IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

On the Use of Hierarchies to Complete Contracts when Players Have Limited Abilities

  • M. Martin Boyer

Why do larger corporations have more layers in their hierarchy? My contention in this paper is that hierarchies arise because economic agents have limited ability to anticipate and ascertain every possible contingency they are faced with. As a result, the complete contract may become too complex (or too costly) to devise and manage directly. My contention in this paper is that hierarchies may help a limited-ability principal (the organization's president) collect all pertinent information about the productive elements in the organization so that the complete is again possible. The contributions of the paper are six-fold: 1) it suggests a reason why hierarchies exist; 2) it develops a measure of the quantity of information that needs to be processed at each level of the organization; 3) it measures endogenously the optimal number of layers in a hierarchy given the players' ability to process information; 4) it provides a rationale for having the most talented individuals at the top of the hierarchy; 5) it offers an explanation for the existence of an unique president in an organization; and 6) it explains how the number of layers and of managers may vary over time as the company grows and/or the players' ability changes. Dans cet article je m'intéresse à la raison pour laquelle les organisations publiques comme privées ont recours à une hiérarchie informationnelle. Je propose un modèle théorique qui explique l'existence des hiérarchies comme étant un outil nécessaire pour aider les agents à récolter le plus d'information possible étant donné leurs capacités limitées. Ainsi, à cause de cette limite intellectuelle et/ou computationnelle des agents économiques au sein des organisations, le contrat complet est trop complexe pour être mis en oeuvre dans les organisations à moins d'utiliser une structure pyramidale pour gérer l'information. En fait, les hiérarchies permettent de récolter plus d'informations à moindre coût. Les contributions de l'article sont les suivantes: 1) il suggère une raison à l'existence des hiérarchies; 2) il développe une mesure de la quantité d'information qui doit être gérée au sein d'une organisation; 3) il mesure de manière endogène le nombre optimal de niveaux au sein de la hiérarchie organisationnelle étant donné les capacités limitées des agents; 4) il rationalise le fait d'avoir les individus les plus talentueux au haut de la pyramide; 5) il donne une explication au fait d'avoir un seul président dans l'organisation; et 6) il explique comment le nombre de niveaux et le nombre de gestionnaires varient lorsque l'entreprise grandit ou lorsque les tâches des agents changent.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.cirano.qc.ca/files/publications/2004s-41.pdf
Download Restriction: no

Paper provided by CIRANO in its series CIRANO Working Papers with number 2004s-41.

as
in new window

Length: 35 pages
Date of creation: 01 Aug 2004
Date of revision:
Handle: RePEc:cir:cirwor:2004s-41
Contact details of provider: Postal: 1130 rue Sherbrooke Ouest, suite 1400, Montréal, Quéc, H3A 2M8
Phone: (514) 985-4000
Fax: (514) 985-4039
Web page: http://www.cirano.qc.ca/
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Geanakoplos, John & Milgrom, Paul, 1991. "A theory of hierarchies based on limited managerial attention," Journal of the Japanese and International Economies, Elsevier, vol. 5(3), pages 205-225, September.
  2. Anderlini, L. & Felli, L., 1993. "Incomplete Written Contracts: Undescribable States of Nature," Papers 183, Cambridge - Risk, Information & Quantity Signals.
  3. Dominique M. Demougin & Devon A. Garvie, 1991. "Contractual Design with Correlated Information under Limited Liability," RAND Journal of Economics, The RAND Corporation, vol. 22(4), pages 477-489, Winter.
  4. Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers 367, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Sappington, David, 1983. "Limited liability contracts between principal and agent," Journal of Economic Theory, Elsevier, vol. 29(1), pages 1-21, February.
  6. Radner, Roy, 1986. "The Internal Economy of Large Firms," Economic Journal, Royal Economic Society, vol. 96(380a), pages 1-22, Supplemen.
  7. Nahum Melamad & Dilip Mookherjee & Stefan Reichelstein, 1996. "Contract Complexity, Incentives and the Value of Delegation," Papers 0070, Boston University - Industry Studies Programme.
  8. Kathy Cannings, 1988. "The Earnings of Female and Male Middle Managers: A Canadian Case Study," Journal of Human Resources, University of Wisconsin Press, vol. 23(1), pages 34-56.
  9. McAfee, R Preston & Reny, Philip J, 1992. "Correlated Information and Mechanism Design," Econometrica, Econometric Society, vol. 60(2), pages 395-421, March.
  10. Alchian, Armen A & Demsetz, Harold, 1972. "Production , Information Costs, and Economic Organization," American Economic Review, American Economic Association, vol. 62(5), pages 777-95, December.
  11. Krasa, Stefan & Villamil, Anne P, 1994. "Optimal Multilateral Contracts," Economic Theory, Springer, vol. 4(2), pages 167-87, March.
  12. Bond, E.W. & Crocker, K.J., 1993. "Hardball and the Soft Touch: The Economics of Optimal Insurance Contracts with Costly State Verification and Endogenous Monitoring Costs," Papers 10-93-1b, Pennsylvania State - Department of Economics.
  13. Picard, Pierre, 1996. "Auditing claims in the insurance market with fraud: The credibility issue," Journal of Public Economics, Elsevier, vol. 63(1), pages 27-56, December.
  14. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 399-415, May.
  15. Aoyagi, Masaki, 1998. "Correlated Types and Bayesian Incentive Compatible Mechanisms with Budget Balance," Journal of Economic Theory, Elsevier, vol. 79(1), pages 142-151, March.
  16. Segal, Ilya, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 57-82, January.
  17. Dye, Ronald A, 1985. "Costly Contract Contingencies," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(1), pages 233-50, February.
  18. Bolton, Patrick & Dewatripont, Mathias, 1994. "The Firm as a Communication Network," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 809-39, November.
  19. M. Martin Boyer, 2001. "Contracting under Ex Post Moral Hazard and Non-Commitment," CIRANO Working Papers 2001s-30, CIRANO.
  20. Orbay, Hakan, 2002. "Information Processing Hierarchies," Journal of Economic Theory, Elsevier, vol. 105(2), pages 370-407, August.
  21. McAfee, R Preston & McMillan, John, 1995. "Organizational Diseconomies of Scale," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(3), pages 399-426, Fall.
  22. Robert, Jacques, 1991. "Continuity in auction design," Journal of Economic Theory, Elsevier, vol. 55(1), pages 169-179, October.
  23. Lambert, Richard A., 2001. "Contracting theory and accounting," Journal of Accounting and Economics, Elsevier, vol. 32(1-3), pages 3-87, December.
  24. Anderlini, Luca & Felli, Leonardo, 1998. "Incomplete Contracts and Complexity Costs," MPRA Paper 28483, University Library of Munich, Germany.
  25. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  26. M. Martin Boyer & Patrick Gonzalez, 2000. "Optimal Audit Policies with Correlated Types," Econometric Society World Congress 2000 Contributed Papers 1514, Econometric Society.
  27. Alain Pinsonneault & Kenneth L. Kraemer, 1997. "Middle Management Downsizing: An Empirical Investigation of the Impact of Information Technology," Management Science, INFORMS, vol. 43(5), pages 659-679, May.
  28. Andrzej Baniak & Jacek Cukrowski, 1999. "Organizational restructuring in response to changes in information-processing technology," Review of Economic Design, Springer, vol. 4(4), pages 295-305.
  29. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  30. Cremer, Jacques & McLean, Richard P, 1985. "Optimal Selling Strategies under Uncertainty for a Discriminating Monopolist When Demands Are Interdependent," Econometrica, Econometric Society, vol. 53(2), pages 345-61, March.
  31. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  32. Gale, Douglas & Hellwig, Martin, 1989. "Repudiation and Renegotiation: The Case of Sovereign Debt," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(1), pages 3-31, February.
  33. Stefan Krasa & Anne P. Villamil, 2000. "Optimal Contracts when Enforcement Is a Decision Variable," Econometrica, Econometric Society, vol. 68(1), pages 119-134, January.
  34. Rasmusen Eric Bennett, 2001. "Explaining Incomplete Contracts as the Result of Contract-Reading Costs," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 1(1), pages 1-39, October.
  35. Brusco, Sandro, 1998. "Unique Implementation of the Full Surplus Extraction Outcome in Auctions with Correlated Types," Journal of Economic Theory, Elsevier, vol. 80(2), pages 185-200, June.
  36. Radner, Roy, 1993. "The Organization of Decentralized Information Processing," Econometrica, Econometric Society, vol. 61(5), pages 1109-46, September.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:cir:cirwor:2004s-41. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Webmaster)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.