Complementarity, Organizational Structure, and Incentives

Abstract

This paper considers the implications of production externalities on organizational structure decisions and the design of optimal incentives for segment managers. It is assumed that the firm produces multiple products in multiple countries and that complementarities are present when managers are assigned by country, but not when they are assigned by product. The principal tension governing how the firm is organized is between a heterogeneity loss due to aggregating performance measures when divisions are organized by country and the productivity gains and positive information externalities available under that organizational structure. A basic insight is that divisional profits are more informative as signal in contracting with managers when their efforts applied to production are complements. This enhanced informativeness improves contracting efficiency by mitigating the implicit costs of the heterogeneity loss in this case. While the analysis is usefully illustrated by the product versus geographic divisions choice, it would seem to apply more broadly to many settings in which task assignments impact on the presence of production externalities.

Keywords: complementarity, task assignment, incentive

JEL Classification: D2, L0, M4