Working Paper: CEPR ID: DP2443
Authors: David Besanko; Pierre Rgibeau; Katharine Rockett
Abstract: This paper studies the choice of organizational forms in a multi-task principal-agent model. We compare a functional organization in which the firm is organized into functional departments such as marketing and R&D to a product-based organization in which the firm is organized into product lines. Managers' compensation can be based on noisy measures of product-line profits. Measures of a functional area's contribution to total profits are not available, however. This effect favours the product organization. However, if there are significant asymmetries between functional area contributions to organizational success and cross-product externalities within functions, organizing along functional lines may dominate the product organization. We also consider the effects of diseconomies of span of control and cross-functional complementarities. Diseconomies of span of control sometimes favours the product organization and sometimes favour the functional organization. Cross-functional complementaries tend to make the product organization relatively more profitable.
Keywords: organizational form; functional organization; product organization; principal-agent models
JEL Codes: D20; L00; L10; L20; M20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| product-based organization (L23) | lower agency cost (D23) |
| functional organization (L23) | higher agency cost (D82) |
| asymmetries between functions (D51) | enhance relative performance of functional organization (L25) |
| cross-product externalities (D62) | higher profitability in functional organization (L21) |
| cross-functional complementarities (L22) | shift profitability advantage to product organization (L21) |
| ability to measure profit contributions accurately (L25) | influence choice of organizational structure (L22) |