A Double Moral Hazard Model of Organization Design
34 Pages Posted: 26 Dec 2007
Date Written: December 2007
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: Suggested Citation