Communication and the Optimality of Hierarchy in Organizations

This paper studies optimal organization structures in multidivisional organizations with more than two divisions. The decisions of individual divisions need to be adapted to local conditions and also be coordinated. The needs for coordination are described by a coordination network. Information about local conditions is held by division managers who communicate strategically. Hierarchy is an organizational form in which divisions are organized into groups, and decisions are made by group managers. Under a circle coordination network, our central result is that when the needs for coordination are intermediate, hierarchy performs better than centralization or decentralization. We then compare M-form hierarchy (in which mutually more dependent divisions are grouped together) and U-form hierarchy (in which mutually less dependent divisions are grouped together). We also consider other coordination networks, in which di¤erent divisions have di¤erent network positions. Hierarchy, or some hybrid governance which combines hierarchy and centralization, remains optimal in some situations. Keywords: Coordination, Cheap talk, Hierarchy, M-form, U-form JEL classi…cation: D23, D83, L23