The Hierarchical Organization of Management in the Firm: Economic Reasons and Efficient Structures

Abstract

Based on analysis of organizational aspects of data processing in decision making, an economic explanation of hierarchical organization of management in firm is provided. Contrary to prevailing opinion that the explanation of hierarchy may in many cases be more sociological and psychological than purely economic in mainstream sense (Radner, 1992, p. 1384) paper shows that decreasing returns to scale in information processing is a necessary condition for hierarchical organization of management in business firms. However, decentralization of decision-making is desirable only if an additional (sufficient) condition is satisfied, i.e., if information workload of decision-making sector is sufficiently large. Moreover, paper shows that specific features of human information-processing in firm such as disagreement about goals of data analysis or possibility of random errors do not imply a hierarchical organization of management, but could change forms of efficient decision-making structures. Finally, contrary to results recently presented in economic literature, paper shows that in firm, unlike in computer systems, there is no unique architecture for efficient information-processing structures, but a number of various efficient forms can be observed.