Working Paper: NBER ID: w7546
Authors: Raghuram G. Rajan; Luigi Zingales
Abstract: A fundamental problem entrepreneurs face in the formative stages of their businesses is how to provide incentives for employees to protect, rather than steal, the source of organizational rents. We study how the entrepreneur's response to this problem will determine the organization's internal structure, growth, and its eventual size. In particular, our model suggests large, steep hierarchies will predominate in physical capital intensive industries, and these will typically have seniority-based promotion policies. By contrast, flat hierarchies will be seen in human capital intensive industries. These will have up-or-out promotion systems, where experienced managers either become owners or are fired. Furthermore, flat hierarchies will have more distinctive technologies or cultures than steep hierarchies. The model points to some essential differences between organized hierarchies and markets.
Keywords: entrepreneurship; organizational structure; incentives; expropriation; firm growth
JEL Codes: D23; I22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| access to critical resources (Q34) | risk of expropriation by managers (G34) |
| organizational design (horizontal vs. vertical hierarchies) (L22) | managerial behavior (specialization or competition) (L29) |
| seniority-based promotion policies in physical capital-intensive industries (J62) | managerial specialization (M54) |
| up-or-out promotion systems in human capital-intensive industries (J62) | managerial competition (L13) |
| risk of expropriation by managers (G34) | need for entrepreneurs to design organizations carefully (L26) |
| allocation of ownership over resources (P26) | incentives for managers to specialize (M52) |
| degree of expropriability of technology (O39) | evolution of organizational structure (L22) |
| costs associated with specialization (D23) | evolution of organizational structure (L22) |
| organizational structure (L22) | organizational performance and growth trajectories (L25) |