Organizational Design and Environmental Volatility

I investigate the impact of environmental volatility and the cost of information on the preferred organizational structure, as determined by the allocation of decision rights, the compensation structure of the managers and the degree of operational integration (such as the use of shared distribution and marketing channels across the operating divisions). The results are broadly consistent with the common wisdom regarding the …t between organizational design and the environment, with stable environments generally populated by tightly integrated and centralized organizations and volatile environments populated by loosely integrated and decentralized organizations. The relationship between decentralization and volatility is, however, re…ned in two ways. First, the equilibrium relationship between decentralization and volatility can be non-monotone, with decentralization arising as the preferred governance structure in both highly stable and highly volatile environments. Second, even if decentralization and volatility are generally positively associated in equilibrium, simply decentralizing decision-making as a response to an increase in volatility will actually worsen organizational performance unless the other design parameters are also adjusted appropriately.