• Selected
• Entire List

Abstract:
A theory of optimal internal organizational structure of the firm as a problem of governing the internal trade in a firm's resources is presented and analyzed in this paper. A principal faces several agents in a multi-product organization who are differentially and privately-informed about revenue prospects and quality of an organizational asset. I analyze first a "structure-less organization" in which there is free communication and coalition-formation among players including the principal. In this environment and under complete contracting, I show that when a productively-critical agent can control the allocation of his own labor services and can withold information on allocative efficiency of resources he becomes the nexus of competing interests within the organization and can thereby capture its disposable rents. This results in no loss of allocative efficiency of the organization and no complete contract offered by the principal can alter this outcome in equilibrium. Information hoarding is consistent with numerous
observations by organizational behaviorists and economic historians.

I show that a solution for the principal is to impose an incomplete-contract mechanism, where the principal ignores efficiency-enhancing messages from agents. This mechanism functions as an authority structure and provides rent-extraction for the principal but decreases the allocative efficiency of the organization. I characterize how the principal optimally structures trade in resources between authority centers.

The model shows how authority functions like "intra-organizational property rights" in assigning to the authority-holders exclusive rights of use and intra-organizational trade over dedicated shares of the critical agent's labor services. This provides a rationale for the employment relationship: elimination of personal discretion over allocation of the critical agent's labor services becomes a pre-condition of his access to the principal's productive assets. An implication is that worker-controlled firms will not exist in cases in which productive assets must be provided by an outside principal without an external enforcement mechanism.