Choice Interaction and Organizational Structure*

We examine how a firm’s formal organizational structure affects its ability to cope with interdependent decisions. An agent-based simulation, in which firms struggle to discover good sets of decisions, allows us to examine four coordinating mechanisms that have rarely been analyzed jointly: the grouping of related decisions under a single subordinate, a vertical hierarchy that reviews proposals from subordinates, firm-level incentives, and managers who are able to process more information. We find that organizational structure affects long-term performance by influencing the number and nature of “sticking points”—configurations of choices the organization will not change. We identify each of the four coordinating mechanisms as a force that either encourages firms to explore a broad set of alternatives or stabilizes firms around existing choices. Successful firms strike a balance between exploration and stability. The need to balance exploration and stability generates interdependencies among the coordinating mechanisms. As a result, firms sometimes benefit from seemingly harmful features: avoidable decision interdependence between departments, a passive CEO, or subordinates of limited ability. We further examine how appropriate organizational design depends on the underlying pattern of interaction among decisions. When interactions are pervasive, successful organizations employ coordinating mechanisms that promote broad exploration.