THE ECONOMICS OF
ORGANIZATIONAL
DESIGN.
A study of the managerial
hierarchy of high-tech start-ups
Massimo G. Colombo
Politecnico di Milano,
Department of Management, Economics and
Industrial Engineering
1
THE ECONOMICS OF
ORGANIZATIONAL
DESIGN
Massimo G. Colombo & Marco Delmastro
2
Objective of the book
• Popular approach to the study of the organization of
firms (John Roberts, The modern firm, 2004): it typically
mixes:
– real facts based on anecdotal business evidence and case
studies
– with conceptual and theoretical insights.
• Key weakness: lack of a generalizable framework.
• Aim of the book:
– Provide a framework grounded in economic theory in which
firms’ organization can be quantitatively analyzed in a multidimensional space;
– Focus attention on a limited set of key dimensions of
organizational design: allocation of power, corporate hierarchy,
incentive structure, & management practices;
– Analyze variations across firms and over time of these key
dimensions;
– Use this evidence to assess empirically the explanatory power of
arguments proposed by the theoretical literature.
3
Content of the book
• Provide a systematic review of the existing quantitative
empirical evidence on (selected dimensions of)
organizational design coming from disciplines as diverse
as industrial economics, personnel economics, business
history, organization and management studies, industrial
relations, and sociology.
• Propose a new empirical framework aimed at defining (a
limited set of) standardized quantitative indicators of
organizational design that are suitable to be used in
econometric work.
• Use the stylized facts that result from both existing
quantitative empirical studies and our framework to test
theoretical predictions that are derived from the
theoretical economic literature about the determinants of
organizational design, its evolution and its effects on firm
performance.
4
On the managerial
professionalization of hightech start-ups: the
determinants of the creation of
a middle-management level
Massimo G. Colombo & Luca Grilli
Politecnico di Milano, Department of Management,
Economics, and Industrial Engineering
5
Objective of the paper
• Number of levels (depth) of the management hierarchy:
key characteristic of organizational design (Simon, 1945;
Colombo and Delmastro, 2008)
• Growing interest from the theoretical literature in
economics (e.g. Williamson 1967; Keren and Levhari
1979, 1983; Radner 1992, 1993; Bolton and Dewatripont
1994; Qian 1994; Van Zandt 1998; Garicano 2000;
Garicano and Rossi-Harsberg, 2006)
• Lack of large-scale quantitative empirical evidence on its
determinants (in spite of early work in the 1960s and
1970s: e.g. Aston group, Child 1973).
• With few exceptions (Wang 2006), available quantitative
evidence mostly confined to large firms (Rajan and Wulf
2006).
6
• Focus on independent (owner-managed) new
technology-based firms (NTBFs).
• Econometric analysis of the decision of ownermanagers to introduce an intermediate
management level into firm’s organization and to
partially delegate decision authority downward
the corporate hierarchy:
– Why do some NTBFs appoint a salaried middle
manager more rapidly than other NTBFs?
• Small across-firm heterogeneity: more precise
test of the predictions of different streams of the
theoretical economic literature.
7
The benefits from the creation of
a middle management level (I)
• Information processing stream:
– Reduction of information overload of ownermanagers (Sah and Stiglitz 1986; 1988);
– Reduction of delay in decision making
(Radner 1992; Van Zandt 1998);
– Knowledge hierarchy: Specialization of
decision tasks between owner-managers and
middle managers (Bolton and Dewatripont
1994; Garicano 2000; Harris and Raviv 2002;
Garicano and Rossi-Harsberg 2006).
8
The benefits from the creation of
a middle management level (I)
• Decentralization of incentive stream:
– Better monitoring of line workers (Calvo and
Wellisz 1978);
– Delegation allows:
• To take advantage of middle managers’ specific
knowledge (Aghion and Tirole 1997; Baker et al.
1999; Raith 2005);
• To motivate the newly appointed middle
manager(Van den Steen 2006).
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The costs from the creation of a
middle management level (I)
• Decentralization of incentive stream:
– Loss of control by owner-managers over decisions
that are delegated to middle managers (Aghion and
Tirole 1997);
– Greater costs:
• The less aligned middle managers’ objectives are with those
of owner-managers;
• The more difficult it is for owner-managers to monitor middle
managers’ behavior.
• The greater the potential losses to the firm from middle
managers’ opportunistic behavior.
10
Labor market conditions
• Imperfections in the labor market make it
difficult for NTBFs to hire skilled middle
managers:
– Information asymmetries (adverse selection);
need for credible signals of firm’s quality;
– Commitment of relation specific investments
by middle managers & high switching costs in
the labor market;
– High search costs for candidates.
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Theoretical predictions
Information
processing
Decentraliz. of
incentives
Firm size
+
(info overload)
+ (monitoring)
+
Firm growth
+
(info overload)
+ (monitoring)
+
Firm age
Labor market
Total
effect
+ (info
asymmetries
N. founders
(info overload)
- (monitoring)
Management
competencies
(info overload)
- (monitoring)
+
(signal)
?
12
Theoretical predictions
Information
processing
Decentraliz. Labor market Total
of incentive
effect
Founders’ human
capital
+
(knowledge
hierarchy)
+
(signal)
+
Heterogeneity of
founders’
competencies
(info
overload)
+
(transaction
costs)
?
VC-backed
+
(loss of
control)
+
(signal/
transaction
costs)
+
Innovation
output
(loss of
control)
+
(signal)
?
13
Theoretical predictions
Information
processing
Decentraliz. of
incentive
Labor market
Total
effect
Competition
+
(urgency)
+
(loss of control)
+
(switching costs)
+
Differentiation
(urgency)
(loss of control)
(switching costs)
-
(info asymmetries)
-
Uncertainty
Appropriability
Control: Local
education
endowment
+
(loss of control)
+
+
(switching costs
/transaction costs)
+
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The sample
• 524 Italian NTBFs:
•
•
•
•
Established in 1980 or later;
Independent;
Having survived up to the end of 2003;
In high-tech industries in manufacturing and
services;
• Representative of a population of 1974 firms
(RITA Directory).
• Surveyed in 2000, 2002 and 2004.
15
• Hand-collected longitudinal dataset:
• Data on managerial professionalization: dates of the
appointment of the first salaried manager;
• Firm-specific data relating to the 1994-2003 period:
firm size (number of employees, sales);
• Data on VC financing: dates of investment rounds,
type of investor (FVC, CVC);
• Data on other firm-specific characteristics (e.g.
human capital of founders);
• Data on industry- and location-specific characteristics.
• Methodology of the econometric analysis:
• Survival data analysis model: hazard rate of hiring the
first salaried middle manager (Weibull and Cox
models)
• Probit analysis for robustness (see infra)
16
Descriptive statistics/1
Descriptive statistics/2
18
Smoothed hazard rate of 1°
manager introduction
19
Results of the estimates/1: Survival
20
Results of the estimates/2: Survival
21
Results of the estimates/3: Probit
22
Comparison with theoretical
predictions/1
Information
processing
Decentraliz. of
incentive
Firm size
+
(info overload)
+
(monitoring)
+
Firm growth
+
(info overload)
+
(monitoring)
+
Firm age
Labor
market
Total
effect
+
(info
asymmetries)
N. founders
(info overload)
(monitoring)
Management
competencies
(info overload)
(monitoring)
+
(signal)
?
23
Comparison with theoretical
predictions/2
Information
processing
Decentraliz.
of incentive
Labor market
Total
effect
Founders’ human
capital
+
(knowledge
hierarchy)
+
(signal)
+
Heterogeneity of
founders’
competencies
(info overload)
+
(transaction
costs)
+
IVC-backed
(does not hold for
CVC-backed)
+
(loss of
control)
+
(signal/
transaction
costs)
+
Innovation output
(loss of
control)
+
(signal)
?
24
Comparison with theoretical
predictions/3
Information
processing
Decentraliz. of
incentive
Labor market
Total
effect
Competition
+
(urgency)
+
(loss of control)
+
(switching costs)
+
Differentiation
(urgency)
(loss of control)
(switching costs)
-
(info asymmetries)
-
Uncertainty
Appropriability
Control:
local education
endowment
+
(loss of control)
+
(switching
costs/transaction
costs)
+
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Conclusions
• Research question:
– What determines the likelihood of a ownermanaged NTBF appointing a salaried middle
manager and (partially) delegating decision
authority to her?
• Estimates based on a sample of 524
Italian NTBFs observed from foundation.
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Result n. 1
• Econometric results in line with the predictions of both
the information processing and decentralization of
incentives streams of theoretical literature.
• Key determinant: size of firm’s operations:
– A) Information overload;
– B) Difficult to monitor workers.
• (A) creates more severe problems in a highly
competitive environment, where decision delays are
very detrimental to the firm.
• Weak evidence that (A) and (B) are more difficult to be
dealt with when there are few owner-managers and they
lack entrepreneurial and managerial experience.
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Results n. 2
• NTBF as a “knowledge hierarchy”:
– the greater the human capital of owner-managers and
the greater the opportunity cost of their time, the more
likely the appointment of a salaried middle manager;
– Delegation of operating tasks to middle managers
allows to capture the benefits from “specialization of
tasks” between owner-managers and salaried middle
managers.
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Results n. 3
• Loss of control :
– Weak evidence in support of the argument that the
extent of loss of control problems deters appointment
of a salaried middle manager;
– No evidence that loss of control problems depend
negatively on the appropriability regime of technology
and positively on the technological position of the
focal NTBF;
– If benchmarking is difficult (e.g. differentiated
products sold in markets with few competitors) loss of
control problems might deter appointment of a
salaried middle manager;
– But these results may depend on other effects
(urgency, swithching costs in the managerial labor
market).
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Result n. 4
• Importance of transaction costs and adverse selection
problems in the market for middle managers: the
likelihood of the creation of a middle management level:
– Increases with firm age;
– Decreases with the uncertainty of the business environment.
– Increases with the business contacts of owner-managers.
• Evidence as to the role of “signals” of firm’s quality:
– Positive effect of the human capital of owner-managers (possibly
because of the “knowledge hierarchy” argument);
– Positive effect of IVC (possibly because of the positive effect of
the reduction of loss of control problems).
– No effect of CVC (pointing to the different nature of this investor)
30