The Economics of Organizational Design

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The Economics ofOrganizational DesignTheoretical Insights and Empirical Evidence

Massimo G. ColomboPolitecnico di Milano

and

Marco DelmastroAutorità per le Garanzie nelle Comunicazioni

© Massimo G. Colombo and Marco Delmastro 2008

All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission.

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Softcover reprint of the hardcover 1st edition 2008 978-1-4039-8741-9

ISBN 978-1-349-54139-3 ISBN 978-0-230-58220-0 (eBook)DOI 10.1057/9780230582200

To Elise, Emilia, Ludovica and Raffaella

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Contents

List of Figures and Boxes xii

List of Tables xiii

List of Abbreviations xvi

Acknowledgments xviii

Preface xx

Introduction: A New View of Organizational Design 1I.1 Preliminary issues in the study

of the organization 4I.1.1 The concept of organization 4I.1.2 Unit of analysis 5

I.2 An overview of a new approach to the study of organization 5I.2.1 The roots of the new approach 5

I.2.1.1 Organization science 6I.2.1.2 Business history 6I.2.1.3 Management studies 10I.2.1.4 Economic theory 11

I.2.2 A new approach to the study of organizational design 11

I.3 The substance of the economicsof organizational design 13I.3.1 Transaction cost economics 14I.3.2 The information processing stream 15I.3.3 The decentralization of incentive stream 17I.3.4 On the dynamics of organizational design 20

1 A New Quantitative Empirical Methodologyfor the Analysis of Organizational Design and Dynamics 231.1 Introduction 231.2 Measures of organizational design 25

1.2.1 Structural organizational variables: configuration and centralization 25

vii

1.2.1.1 Configuration: measures of corporate hierarchy 26

1.2.1.2 Centralization: measures of the allocation of decision authority 27

1.2.2 Organizational practices 311.3 International evidence on organizational

design and its dynamics 321.3.1 Evidence on structural organizational variables 32

1.3.1.1 A brief survey of the empirical literature 321.3.2 Evidence on structural organizational variables

based on the new empirical methodology 361.3.2.1 Evidence on organizational

depth and shape 371.3.2.2 Evidence on the allocation

of authority 421.3.2.3 A synthesis 49

1.3.3 Evidence on the use of organizationalpractices 50

1.4 Concluding remarks 55

2 The Determinants of the Allocation of Decision Authority 572.1. Introduction 572.2 A conceptual framework of the determinants

of the allocation of decision authority 582.2.1 The benefits and costs of delegation

of decision authority 582.2.1.1 The benefits of delegation 582.2.1.2 The costs of delegation 60

2.2.2 The determinants of the delegationof decision authority 61

2.3 Empirical evidence on the determinants of the allocation of decision authority 672.3.1 The work of the Aston group 672.3.2 More on the role of size and technology 692.3.3 Country-specific effects 722.3.4 New directions in the empirical literature

on the determinants of decentralization 752.3.5 A synthesis 78

2.4 Evidence on the determinants of the allocation of decision authority based on the new empirical methodology 82

viii Contents

Contents ix

2.4.1 The data 822.4.2 The econometric model 84

2.4.2.1 Specification of the econometric model 84

2.4.2.2 Explanatory variables 852.4.3 Econometric results 882.4.4 A synthesis 93

2.5 Concluding remarks 95Appendix 992.A.1 Definition and expected effects

of the explanatory variables, and results of the econometric estimates 99

3 The Determinants of the Corporate Hierarchy 1083.1 Introduction 1083.2 A conceptual framework of the

determinants of organizational depth 1103.3 Empirical evidence on the determinants

of organizational depth 1143.3.1 Size 1153.3.2 Technological variables 1163.3.3 Other firm-specific and

industry-specific effects 1183.4 Evidence on the determinants of organizational

depth based on the new empirical methodology 1193.4.1 Specification of the econometric model 1193.4.2 Explanatory variables 1203.4.3 Econometric results 1223.4.4 A synthesis 125

3.5 Concluding remarks 127Appendix 1303.A.1 Definition and expected effects of the

explanatory variables, and results of the econometric estimates 130

4 Evidence on the Determinants of Organizational Dynamics 1354.1 Introduction 1354.2 A conceptual framework of the determinants

of organizational dynamics 1364.2.1 A general framework of organizational

dynamics 136

x Contents

4.2.1.1 Factors affecting the additional operating revenues from organizational innovations 137

4.2.1.2 The adjustment costs associated with organizational innovations 138

4.2.2 Testable predictions on the determinants of changes in the organizational depth 139

4.3 Empirical evidence on the determinantsof the adoption of organizational practices 1434.3.1 Work in the steel industry 1434.3.2 Work related to other industries 147

4.3.2.1 Automobile assembly industry 1474.3.2.2 Apparel industry 148

4.3.3 Cross-industry evidence 1494.4 Empirical evidence on the determinants

of changes in structural organizational variables 1554.4.1 Empirical evidence on the determinants of

the adoption of organizational forms 1554.4.2 Empirical evidence on the determinants

of the “flattening” of the corporate hierarchy 1554.4.3 Evidence on the determinants of

organizational dynamics based on the new empirical methodology 1624.4.3.1 Specification of the econometric

models 1624.4.3.2 Explanatory variables 1654.4.3.3 Econometric results 1674.4.3.4 A synthesis 173

4.5 Concluding remarks 176Appendix 1814.A.1 Methodological issues 1814.A.2 Definition and expected effects

of the explanatory variables, and resultsof the econometric estimates 182

5 The Effects of Organizational Design on Firm Performance 1925.1 Introduction 1925.2 Methodological issues 193

5.2.1 Measurement of performance 1935.2.2 Unit of analysis 1945.2.3 Characteristics of data sets 194

Contents xi

5.2.4 Econometric methodology 1955.3 Effects of organizational design

on productivity 1975.3.1 Single-industry studies 197

5.3.1.1 Steel industry 1975.3.1.2 Automobile assembly industry 2005.3.1.3 Machining 2005.3.1.4 Telecommunication services 2015.3.1.5 Business services 202

5.3.2 Cross-industry evidence 2035.3.2.1 Cross-section estimates 2035.3.2.2 Panel data estimates 206

5.4 Effects of organizational design on firm profitability 2105.4.1 Previous empirical evidence 2105.4.2 Evidence based on the new empirical

methodology 2115.5 More on the complementarity between

technological and organizationalinnovations 214

5.6 Concluding remarks 216

Conclusions 223

Appendix: Data Set and Empirical Methodology 229

Notes 235

References 248

Index 263

List of Figures and Boxes

Figures

1.1a Decision-making structure: strategic decisions 281.1b Decision-making structure: operating decisions 292.1 Size, use of advanced network technologies,

and probability of centralization of decision authority 90

Boxes

I.1 The passage from the pre-modern to the modern form of organization 7

I.2 The U-form 8I.3 The M-form 9I.4 The lean organization (J-form) 10

xii

List of Tables

1.1 Evolution of structural organizational variables, US and Europe 34

1.2 Number of hierarchical levels (Level) and plant size, distribution, and tests 38

1.3 Number of hierarchical levels (Level), distributionby plant categories 39

1.4 Transition probabilities (pij), number of hierarchical levels (Level) 40

1.5 Span of control (Span), means, and tests 411.6 Degree of centralization (DC) of strategic

decisions, means, and tests 431.7 Transition probabilities (pij), DC of

strategic decisions 441.8 Number of strategic decisions (ND) taken

by each hierarchical level 451.9 Degree of concentration (Std_Conc) of

strategic decisions, means, and tests 461.10 Degree of centralization (DC) of operating

decisions, means, and tests 471.11 Transition probabilities (pij), DC of

operating decisions 471.12 Number of operating decisions (ND) taken

by each hierarchical level 481.13 Degree of concentration (Std_Conc) of

operating decisions, means, and tests 481.14 Use of IWPs and HRMPs: international evidence 521.15 Use of IWPs and HRMPs: international data sets 542.1 Determinants of the decentralization of

decision authority in business organizations 662.2a Quantitative empirical evidence on the

determinants of the decentralization of decision authority: a synthesis 79

2.2b Quantitative empirical evidence on the determinants of the decentralization of decision authority: a synthesis 81

2.3 Explanatory variables of the econometric models 86

xiii

2.4 Expected effects of the explanatory variables on the delegation of decision authority to the plant manager 87

2.5 Detected effects of the explanatory variables on the delegation of decision authority to theplant manager 88

2.A1 Descriptive statistics of the explanatory variables 1032.A2 Results of the estimates of a random effects

ordered probit model 1042.A3 Marginal effects of the explanatory variables 1052.A4 Results of the estimates of random effects

ordered probit models: fixed effects of decisions 1062.A5 Results of the estimates of random effects

ordered probit models: labor versus capital decisions 1073.1 Determinants of organizational depth:

theoretical predictions 1133.2 Correlation between the number of

hierarchical levels and the log of the total number of employees of organizations 115

3.3 The explanatory variables of the econometric models 121

3.4 Detected effects of the explanatory variableson organizational depth 122

3.A1 Descriptive statistics of the explanatory variables 1313.A2 Determinants of organizational depth:

ordererd logit models with censoring 1323.A3 Determinants of organizational depth:

results of tests on groups of explanatory variables 1344.1 Theoretical predictions on the determinants

of organizational dynamics 1434.2 Determinants of the diffusion of

organizational practices: evidence from steel finishing lines 145

4.3a Determinants of the diffusion of organizationalpractices: cross-industry evidence 150

4.3b Determinants of the diffusion of organizationalpractices: cross-industry evidence 152

4.4 Determinants of delayering: evidence fromquantitative studies 157

4.5 Explanatory variables of change in organizational depth 1664.6 Determinants of change in organizational

depth: results of the econometric models 168

xiv List of Tables

List of Tables xv

4.7 Evidence on organizational dynamics 1744.A1 Econometric models of change in

organizational depth 1874.A2 Impact of technological complementarities

on change in organizational depth 1884.A3 Econometric models of expansion and

contraction of organizational depth 1894.A4 Impact of technological complementarities on the

expansion and contraction of organizational depth 1915.1a Cross-industry studies on the effect of

organizational design on firm (or plant) performance: characteristics of the empirical methodology 217

5.1b Cross-industry studies on the effect of organizational design on firm (or plant) performance: effects of organizational variables 219

A.1 Size and geographical distribution of sample plants 231A.2 Industry distribution of sample plants 232A.3 List of the Variables of FLAUTO97 233

List of Abbreviations

AMTs advanced manufacturing technologiesBIC Bilans industriels et commerciauxCAD computer aided designCAM computer aided manufactureCEO chief executive officerCF control functionCNC computerized numerical controlCOI Changements Organisationnels et InformatisationDOF degrees of freedomEDI electronic data interchangeEQW–NES Educational Quality of the Workforce National

Employers’ SurveyER Enquête ReponseESE Enquête sur l’emploiESOP employee stock ownership plantsFMS flexible manufacturing systems and cellsGLS generalized least squareGMM General Method of MomentsGRATE gross rate of return on capitalHR human resourcesHRM human resource managementHRMPs human resource management practicesICTs information and communication technologiesIMS inflexible manufacturing line systemsIT information technologyIV instrumental variableIWPs innovative work practicesJIT just-in-timeJV joint ventureLAN Local Area NetworkLISREL linear structural relationshipM&A merger and acquisitionMNE multinational enterpriseNC numerical controlOLS ordinary least squarePA programmable automation

xvi

List of Abbreviations xvii

PCA principal component analysisQC quality circlesR&D research and developmentROI returns on investmentSMT self-managed teamsSOE state-owned enterpriseSOVs structural organizational variablesTQM total quality managementWERS Workplace Employee Relations SurveyWG within-groupWIRS (British) Workplace Industrial Relations Survey

Acknowledgments

This book is an outgrowth of the research that we have been doing overthe past several years on the organization of firms. Our research workhas benefited enormously from interactions with colleagues and friends.To try to list all the people from whom we received insights, ideas, andencouragement would greatly lengthen the book. However, there aresome individuals who have been especially helpful through the com-ments, criticism and suggestions they provided after reading ourresearch papers and draft chapters of this book. First, Keith Cowling andMike Waterson had a great impact on the work of Marco Delmastro,especially when he was at the University of Warwick doing his PhD. Notonly have they provided theoretical aid and fruitful discussions, butMarco is also personally indebted to Keith for the support he gave whenhe felt lost in his work. Second, the following persons deserve specialmention: Alberto Bacchiega, Paolo Bertoletti, Clelia Di Serio, Luca Grilli,Dennis Leech, Colin Mayer, Rocco Mosconi, Larissa Rabbiosi, and FabioSartori. Third, we want to thank Samantha Cagnoni, Andrea Scazzosi,Giuliana Sovran and especially Diego D’Adda for their outstandingresearch assistance through the development of our research. Our editorat Palgrave Macmillan, Alec Dubber, has shown immense patience withour tardiness and is owed special thanks.

Since this book completes several years of research in this field, somelimited parts of it are revised versions of papers published elsewhere. Inparticular:

● Sections 1.2.1 and 1.3.2 of Chapter 1 are based on a related paper thathas been published by the authors in the Journal of Economic Behavior& Organization, vol. 40 (3), pp. 255–274, 1999, with the title “Somestylized facts on organization and its evolution.” These parts of thepaper are reprinted with the permission of Elsevier.

● Section 2.2.4 of Chapter 2 is based on a related paper that hasbeen published by the authors in the Journal of Industrial Economics,vol. LII (1), pp. 53–80, 2004, with the title “Delegation of authority inbusiness organizations: an empirical test.” These parts of the paperare reprinted with the permission of Blackwell Publishing.

● Section 3.3.4 of Chapter 3 is based on a related paper that has been pub-lished by Marco Delmastro in the International Journal of Industrial

xviii

Acknowledgments xix

Organization, vol. 20 (1), pp. 119–137, 2002, with the title “Thedeterminants of the management hierarchy: evidence from Italianplants.” These parts of the paper are reprinted with the permission ofElsevier.

● Section 4.4.3 of Chapter 4 is based on a related paper that has beenpublished by the authors in the Journal of Economics and ManagementStrategy, vol. 11 (4), pp. 595–635, 2002, with the title “The determi-nants of organizational change and structural inertia: technologicaland organizational factors.” These parts of the paper are reprintedwith the permission of Blackwell Publishing.

Lastly, this book would not have been possible without the patientsupport and the encouragement provided by our families, to whom weare especially indebted.

xx

Preface

In the past 30-years the theoretical economic literature has shown agrowing interest in organizational design. However, this literature hashad very limited interaction with applied work on the internal organi-zation of firms. Part of the problems lies in the difficulty of extractingfrom these theoretical studies testable hypotheses that could be vali-dated or negated through rigorous empirical tests. Nonetheless, “Part ofthe problem underlying the lack of interaction [of theoretical studies]with applied work is that most of the evidence concerning internalorganization of firms comprises case studies and business reports,instead of large scale empirical datasets” (Mookherjee 2006, p. 385). Aswill be documented in this volume, this statement is only partially true,as the empirical evidence on organizational design though ratherheterogenous, is more extensive than what is generally thought by eco-nomic theoreticians. In fact, during the past three decades there hasbeen no shortage of books and articles aimed at analyzing variousaspects of organizations in disciplines as diverse as management, organ-ization science, industrial economics, business history, personnel eco-nomics, and sociology. Often, however, scholars were interested indifferent aspects of organizational design, and they resorted to differentmethodological tools. As a result, this literature is rather fragmented,and the empirical findings on the organization presented by researchersworking in one discipline have rarely been considered by researchersworking in another.

Thus, the first objective of this volume is to systematize and synthe-size the existing quantitative evidence on organizational design comingfrom different disciplines so as to favor mutual fertilization betweentheoretical and empirical work.

With this goal in mind, drawing from studies that have adopteddifferent approaches, we have developed a new empirical frameworkaimed at defining a limited set of quantitative indicators of organiza-tional design that are suitable for use in econometric work.

We use the results of both existing quantitative empirical studies andour own framework to test theoretical predictions about the determi-nants of organizational design, its evolution, and its effects on firmperformance that have been derived from the theoretical economicliterature. In so doing, we also indicate future directions of research.

It is our conviction that quantitative empirical studies are the key“raw material” for developing more rigorous theories of organizationaldesign. In fact, systematic theory must be grounded in and derived fromsystematic empirical facts, a principle that unfortunately has rarely beenfollowed so far in this field.

How to use the book

This work represents, as already said, a bridge between theory andempirics. Hence, it is intended for a broad audience of readers. The firstaudience consists of scholars with an interest in the theory and empiricsof organizational design. This group includes researchers at universitiesand other scientific institutions and graduate students interested inissues relating to the organization of firms from different perspectives:industrial economics, the theory of the firm, business history, manage-ment, and organization studies. The second audience consists of man-agement practitioners. This group includes corporate managers,business consultants, and whoever evaluates and/or takes decisions onhow to organize people and resources within a firm. Finally, this book isalso addressed to psychologists, sociologists, political scientists, and his-torians with an interest in quantitative social research.

Some parts of the book are rather technical, but this should not deterthe interested reader. In fact, we have used an asterisk (*) to indicatethese more technical (usually econometric) sections that the reader mayskip without losing the general progression and the main concepts ofthe chapter. Indeed at the end of each of these more technical parts wehave inserted a section that sums up the main results.

Every chapter develops a self-contained discussion of an aspect oforganizational design. However, the reader should read first Chapter 1where the general concept of organizational design and the empiricalmethodology to analyze it are developed. Then, from Chapter 2 toChapter 5 we tackle single issues which are at the core of the currentdebate on organizational design – i.e. the allocation of decision-makingauthority (Chapter 2), the corporate hierarchy (Chapter 3), the dynamicsof organizational design (Chapter 4), and the relation between organi-zational design and firm performance (Chapter 5). These chapterscontain both conceptual and empirical sections. We anticipate thatmany readers will be interested in relating the conceptual modelsillustrated in each chapter to the theoretical literature on the economicsof organizational design. With those readers in mind, in theIntroduction to the volume we have briefly illustrated the key intuitions

Preface xxi

on which the different theoretical approaches to the study of theeconomics of organizational design hinge. In addition, the Introductionhighlights the (allegedly original) contribution of this book to theextant literature and provides a preliminary account of both the aspectsof organizational design taken into consideration and the quantitativemethodology that we have developed in order to study them. In theConclusion we synthesize the key stylized facts on organizational designthat emerge from this volume and indicate other potential issues forfurther research.

xxii Preface