A Double Moral Hazard Model of Organization Design

34 Pages Posted: 26 Dec 2007

See all articles by Elazar Berkovitch

Elazar Berkovitch

Interdisciplinary Center, Herzliyah

Ronen Israel

Interdisciplinary Center, Herzliyah

Yossi Spiegel

Tel Aviv University, Coller School of Management; Centre for Economic Policy Research (CEPR); ZEW – Leibniz Centre for European Economic Research

Multiple version iconThere are 2 versions of this paper

Date Written: December 2007

Abstract

We develop a theory of organization design in which the firm's structure is chosen to mitigate moral hazard problems in the selection and the implementation of projects. For a given set of projects, the divisional structure which gives each agent the full responsibility over a subset of projects is in general more efficient than the functional structure under which projects are implemented by teams of agents, each of whom specializes in one task. However, the ex post efficiency of the divisional structure may encourage the firm's manager to select more expensive (but still profitable) projects ex ante. We examine how the tradeoff between the ex post inefficiency in the implementation of projects and the ex ante inefficiency in the selection of projects is affected by various factors like size, complexity, and asymmetry in the importance of tasks. We also explore the desirability of adopting a narrow business strategy and the implications of managerial work overload for organizational structure.

Keywords: Divisional structure, functional structure, project selection, moral hazard, moral hazard in teams, narrow business strategy

JEL Classification: D23, L23

Suggested Citation

Berkovitch, Elazar and Israel, Ronen and Spiegel, Yossi, A Double Moral Hazard Model of Organization Design (December 2007). Available at SSRN: https://ssrn.com/abstract=1078504 or http://dx.doi.org/10.2139/ssrn.1078504

Elazar Berkovitch

Interdisciplinary Center, Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

Ronen Israel

Interdisciplinary Center, Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel
972-9-9527306 (Phone)

Yossi Spiegel (Contact Author)

Tel Aviv University, Coller School of Management ( email )

Ramat Aviv, Tel Aviv, 69978
Israel
972-3-640-9063 (Phone)
972-3-640-7739 (Fax)

HOME PAGE: http://www.tau.ac.il/~spiegel

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

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