Working Paper: NBER ID: w7705
Authors: Jeremy C. Stein
Abstract: This paper assesses different organizational forms in terms of their ability to generate information about investment projects and allocate capital to these projects efficiently. A decentralized approach with small, single-manager firms is most likely to be attractive when information about individual projects is soft' and cannot be credibly transmitted. Moreover, holding fixed firm size, soft information also favors flatter organizations with fewer layers of management. In contrast, large hierarchical firms with multiple layers of management are at a comparative advantage when information can be costlessly hardened' and passed along within the hierarchy. As a concrete application of the theory, the paper discusses the consequences of consolidation in the banking industry. It has been documented that when large banks acquire small banks, there is a pronounced decline in lending to small businesses. To the extent that small-business lending relies heavily on soft information, this is exactly what the theory would lead one to expect.
Keywords: No keywords provided
JEL Codes: G21; G31; L22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Decentralization (H77) | Better capital allocation (when dealing with soft information) (G31) |
| Hierarchy (Y10) | Better capital allocation (when information can be hardened) (G31) |
| Nature of information (soft vs. hard) (D83) | Efficiency of capital allocation (D61) |
| Decentralization (H77) | Improved capital allocation efficiency (when information is soft) (G31) |
| Hierarchy (Y10) | Less effective capital allocation (G31) |
| Large banks cut back on small business lending post-merger (G21) | Reliance on soft information (D80) |