Information and coordination in
Organizations
Luis Garicano
NBER, May 2013
Organizations and Coordination
Arrow (1974)
“Organizations are a way of achieving the
benefits of collective action in situations in
which the price system fails”
March and Simon (1993) .
“Organizations are systems of coordinated
action among individuals and groups”
Aims of organization
• Division of labor
– Creates coordination problems
– Creates informational asymmetries
• Resource allocation problem
– Information intensive
– Incentive conflicts
But what does it have to do with
development question
• If markets in developing countries are less
efficient, and market transactions less reliable,
regulators more unpredictable more of the
action will take place inside firms
– Price system more likely to fail
Nick Bloom´s Pictures of textile factories
6
Organizations must deal with
two problems
• Coordination
Assume people were all well intentioned and
share a common goal, must get over bounded
rationality/limited information/limited knowledge
• Motivation
Need to motivate people for the common goal
Coordination and motivation
• Coordination
– Utilization of knowledge
– Communication, ransmission of information
– Allocation of talent
• Motivation
– Informational asymmetries
– Contractual Incompleteness
Coordination matters
• The division of labor is limited by
– Extent of the market (Smith)
– Coordination costs (Becker and Murphy, QJE 93)
• Firms devices to reduce coordination costs (knowledge
divided and integrated)
• Broadly, if firms are bad at solving coordination ,
inefficiently little specialization
Arrow (1974) on Information
Requirements of Price System
• Arrow-Debreu solution to competitive equilibrium
requires agents to have an enormous amount of
information
• This is particularly clear in the case of uncertainty:
– The possibility of using the price system to allocate
uncertainty is limited by the structure of the information
channels in existence.
• What is important here is that the presence or absence
of information channels is not prescribed exogenously
to the economic system.
– The question then is how much information to collect?:
cost/benefits
Transmitting information is not just
about Incentive Compatibility
‘Standard’ neoclassical theory does not really worry
about limits on communication and knowledge
• As long as actions of members are incentive
compatible, they can be implemented. Only private
incentives limit information transmission
• In fact, communication and knowledge acquisition is
very costly
Information costs: is this just
“technology”?
Arrow distinguishes three characteristics of
information costs
(1)Strongly decreasing returns
-- fixed factor is the individual
(2)Irreversible investment aspect
Thus history matters
Information costs (2)
(3) Information costs are different in different
directions
– Things are ‘near’ in some space to others
– Similarly, it is easier to communicate with some
individuals
– Also, complementarities with production activities
Organization and Information Costs
• Arrow argues that an organization can acquire
more information than any individual
• Can economize on the use of information,
– (sufficient statistics, for example)
• Thus an organization is useful for information
handling
– Codes
– Hierarchies
Here focus on coordination role of
organizations
Caveats
• Aim is on understanding underlying
organization mechanisms rather than impact
on growth
– Research must study that!
• A lot of these mechanisms exist within firms,
often also between firms
Application I: ICT impact on
coordination and motivation
Likely to reduce both
– Coordination costs (by making information
cheaper, more readily available)
– Motivation costs (by e.g. hardening information)
Example 1. Paravisini-Schoar (2013)
• A new technology for loan processing: scoring
system
• How does it impact productivity of bank?
– Does it increase the amount of information
employees have, improving decision making and
solving more problems? (coordination)
– Or does it help deal with incentive conflicts by
making information “hard” (motivation)
Example 2. Baker Hubbard, Trucking
(QJE04/AER 03)
• A new technology for trucks: on board
computing
• How does it impact productivity of truckers?
– Better assignment of loads, better coordination of
fleet, resulting from better information and higher
capacity utilization
– Less incentive conflicts on driving, lower moral
hazard
Example 3. Garicano-Kaplan JIE 2001
(B2B Car sales)
Physical Flow
Physical Flow
Dealership
Information Flow
Dealer
Dealership
Dealer
Auction
Also Rental Car Firms
and Manufacturers
Lessor Bank
Also Rental Car Firms
and Manufacturers
Lessor Bank
Auction Vehicle Inventory
Dealer
Dealer
Dealership
Personnel
Transport
Information Systems
Appraisal Company
Dealer (flies in)
Information Systems
Lessee
Dealership
Dealership
Leased Vehicle
Personnel
Transport
Lessee
Personnel
Dealer
Dealer Inventory
Dealer Inventory
Leased Vehicle
Transport
Information Systems
Used Car Customer
Used Car Customer
Coordination
1. Utilizing knowledge optimally
2. Reducing human fallibility
3. Matching jobs with talent/job assignment
4. Corporate culture and knowledge
5. Communication and firm language
1. UTILIZATION OF KNOWLEDGE
Efficiencies of Division of Labor
• Sherwin Rosen:
– Indivisibility of Human Capital Investment (Rosen
1983) “implies a fixed cost element independent
of subsequent utilization of skills.” This implies
that two identical individuals gain by specializing
– the matching of people with activities for which
they are suited (Rosen 1978).
Hierarchy and Utilization of Knowledge
• Hierarchy: A device to match problems with
solutions (Garicano, JPE 2000)
– When matching problems with solutions is very hard,
hierarchies increase the utilization of knowledge of
experts by using less knowledgeable subordinates to
protect them from easy things others can do
– The purpose of the hierarchy is to economize on
cognitive costs; through a hierarchy, a manager can
project his superior knowledge through many
workers. Workers deal with routine questions and
managers with exceptions
Manager
Span of control: number of workers
reporting to manager
Worker autonomy: low if managers take
most decisions; high if workers take most
decisions
Workers
24
HOW DO FIRMS DETERMINE THEIR HIERARCIES?
• Firms face tasks in the interval [0,1] distributed according to density function f(z)
z0
0
Routine
1
Non-routine
Delegated Tasks (Worker)
Centralized Tasks (Manager)
25
• In order to solve problems, the firm needs to train each worker at a training cost a
(information “acquisition”)
• Asking the manager entails a communication cost h (“helping” cost), subject to the
managers total time constraint
• So the optimal organization will balance of training and helping costs, with z0 decreasing
in “a” and increasing in “h”
Knowlegdge based hierarchy (JPE,
2000)
f(z)
zw
z1 z2
z3
z
Management by Exception
Asking for help versus learning
• Worker deals with routine problems, manager
with exceptions
• Information technology, cheaper training, higher
human capital decentralizes, “empowers”
– Makes learning to solve a problem cheap relative to
asking
• Communication technology “centralizes”
– Makes asking others cheaper relative to learning to
solve it
Examples of management by
exception
• Resident - attending physician
• Software customer service /technical support – Orlikowski (1996)
• Paravisini-Schoar (2013) loan processing
• Casaburi and Kremer (2013) farmer queries
• Supervisor - worker in factory floor
• Partner - associate in professional services (GaricanoHubbard, 2010, 2011, 2013)
Key role of middle level managers
(Antras, Garicano, Rossi-Hansberg
2006)
• By shielding top management from routine
problems faced by host country workers, the
presence of middle managers improves the
efficiency of the transmission of knowledge
Key empirical counterparts of theory
Observable Parameters
• Cost of acquiring information, affected by cost of training, IT
• Cost of communicating, helping, affected by networks, phones etc.
• Complexity / predictability of production
Choices
• Span
• Number of layers of management
• Proportion of decisions made below to decisions at higher levels
• Level of training of lower and higher level employees
• Discretion/decisions made by the higher ups
Application 2: Distinguishing IT and Ct
(Bloom, Garicano, Sadun, Van Reenen, 2012)
Clear predictions for information technologies (IT) and communication technologies (CT)
on firm organization
IT will reduce information acquisition costs (a), leading to an:
• Increase in z0 (decentralization) as workers can tackle more tasks
• Increase in s (the span of control) as workers ask less questions so that managers can
direct more people
CT will reduce communication costs (h), leading to:
• A reduction in z0 (centralization) as cheaper to ask for help
• An ambiguous impact on the span of control, as more questions are asked but each
takes less time to ask
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2. FALLIBILITY AND ORGANIZATION
Architecture and Errors
• Starting point: The performance of an organization is
determined by how centralized or decentralized it is
• Individuals have a limited ability to absorb and process
information
• Two main types of architecture:
– Decentralized or Flat (“poliarchy” in S&S):
– Centralized (“Hierarchy “)
• Question: how these two architectures affect quality of
decision making? And how do we allocated talent given
this?
– False Positive
– False negatives
Fallibility of centralized and
decentralized structures
• Decentralized: independent screens
– Accepted projects are those that were accepted
by either one or the other (parallel)
– Probability of acceptance: p(x ) +p(x ) (1 - p(x ))
• Centralized/Hierarchical: successive screens:
– accepted projects are those accepted by both.
(serial).
– Probability of acceptance: p(x ) * p (x)
Comparison
– A decentralized structure selects a larger proportion
of projects than a hierarchy (Proposition 1)
– The incidence of Type-I error is higher in a hierarchy
(reject too much); of Type II in a decentralized
structure (accept too much)
• Trade off consistency versus innovativeness
– Decentralized: “anything goes” advantage: we do not
kill too many good projects; but we let go some bad
stuff
– Centralized/Hierarchy: we are cautious/we do not let
in the bad stuf but we may be too selective.
Empirical counterparts
Parameters
– Relative cost of type I and II errors
• Importance of preserving reputation
• Speed of change in market
Choices
– Number of approvals a new product or design
requires
– Level at which decisions are made
3. JOBS AND TASK ASSIGNMENT
(A BIG RESEARCH FRONTIER)
Fallibility, complementarities and
substitutabilities
• Production with (strong) complementarities: O
Ring (Kremer QJE 93): If anything fails, all fails
– Need homogeneous workforce
– Allocate better workers to latter stages of
production
• Production with substitutability: as long as
anyone knows the answer, we produce
– Need stars
– Heterogeneous talent, as long as some star
Production, Organization and Talent
• Grossman and Maggi, AER 00
– The country with a relatively homogeneous population
exports the good produced by a technology with
complementarities between tasks. The country with a
more diverse workforce exports the good for which
individual success is more important.
• Grossman, JPE 04,
– country with a more heterogeneous labor force exports
the good that is produced by the most talented individuals.
In this country, trade exacerbates the "polarization" of
labor and often worsens the distribution of income.
Key ideas/Empirical Counterparts
• Allocation of talent should depend on
– Decision making
– Complementarities and substitutabilities between
tasks – crucial tasks more talent
– Distribution of risks in tasks- cost of errors
– Uncertainty
– Speed of change
Vertical Allocation of Talent
• Manne’s (1965) suggestion:
– “Observed size distribution is a solution the
problem: allocate productive factors over
managers of different ability so as to maximize
output”
Hierarchies and Talent (Garicano Rossi
Hansberg QJE 06)
1. production requires physical inputs and knowledge
•
problem solving required to produce
2. Individuals choose knowledge acquired
3. Individuals may work on their own or in teams
•
some individuals may communicate knowledge to others
4. Individuals have heterogeneous cognitive ability
Application 3: Garicano, Lelarge, Van
Reenen : French firm size and
productivity
4. CULTURE
COMMUNICATION AND CODES
Culture as a cognitive construct
• Crémer: the seed of an economic approach
based on bounded rationality
• Question: what is the use of corporate
culture?
– Under what conditions are firms depositories of
knowledge?
Cognitive aspects of culture (Crémer,
93)
• Culture: part of the knowledge stock shared
by a substantial portion of the employees of
the firm, but not by the general population
• ‘Shared specific human capital’ or ‘bounded
rationality of firm”’
– Elements
• A common code
• A shared knowledge of facts
• A knowledge of rules of behavior (like Kreps)
Corporate culture and efficiency
• Consider a decision by an individual that
commits his firm
– By knowing facts, rules, agent can predict the
behaviors of others – facilitate coordination
• Trade-off
• Predictability vs. rigidity
– Culture makes communication cheaper
Empirical implications: how common
the culture?
A. Prat, EER 2002: Information received must be
common when coordination matters
– If coordination is important, diversified
information will dampen the reaction to
information about state.
– On the other hand, if coordination is of little
importance, diversified information makes it
feasible for the agents to react- strongly to the
information that they receive
Firms and Culture
• Stability?
– Sunk investment aspect
– Consistency is required for it to perform its
function
Firms and Culture (2)
• Theory of the Firm?
– Selective intervention possible?
• No, the presence of corporate culture imposes fixed
costs of intervention
– and the solution may not be just a bit of integration – but
none.
5. COMMUNICATION AND CODES
Coding and information costs
Since communication channels must be designed,
the code can suitably be chosen for efficiency.
• Coding weakens tendency to decreasing returns
• Creates an irreversible commitment by organization
– Specific investment
– Stability of the code – ‘Identity’ of the organization?
• Important (unresolved) issue: implications for theory
of the firms – one code one firm?
– to decrease difficulties of communication, outsource
functions with different codes?
Firms and Culture: Codes
• How can we model a code? A cognitive aspect
of firm culture?
• What does it imply?
Cremer, Garicano, Prat, QJE 07
• Develop a theory of codes, when agents
communicate with several different other agents.
• Derive some implications for the structure of firms,
and collaboration between firms.
• Use it to understand the impact of certain
information costs on the structure of organizations
– Integration vs. disintegration
– Centralization and use of hierarchies
6. CONCLUSIONS
Firms and capabilities
• Current theory of the firm focused exclusively on incentive issues
(subeconomy/Holmstrom; property rights GHM) ∙
• Alternative view (as in Arrow, Simon, March) sees firm as bringing
more information/knowledge to bear on problems
– In management parlance, firms as bundles of capabilities
• Examples:
– BIC had capabilities in plastic injection molding and mass marketing.
Used it for entry in Disposable Pens (1958),Disposable Lighters
(1973) and Disposable razors (1974).
– Apple's design and marketing capabilties used for entry in PCs,
Laptops, portable music players (IPod), Phones (iPhone), Tables (iPad)
• Hypothesis: Understanding capabilites requires understanding
interaction between bounded rationality and incentives
– As in (Bob G) communicating the caterogies, the content of the
relational contract
Empirical implications and
counterparts: Frontier
• Capabilities
– Knowledge utilization
– Correcting errors-making best decisions
– Job assignment
– Culture
– Common Language common codes
Back to growth question: Coordination
• High coordination costs lead to little
specialization
– Unpredictability high, high communication cost
– Job assignment random (can aim to change it)
does not correspond to job design characteristics
– Leverage of talent limited, middle managers
missing
– Incompatible languages, rules, codes
Motivation
• Motivation
– Multitask incentives
• Output is less measurable?
• Can we outsource less?
– Careers
• Without deep markets, careers matter more inside firms- more
career concerns (each business works less well with less market)
– Relational contracts
• Lack of court enforcement requires more use of relational contract
• Relational contracts perform worse- less future, more uncertainty,
etc (But Bob G. opposite direction also)
– Hold Up more prevalent, less punished? (Raj)