The Flattening Firm and Product Market Competition: The Effect of Trade Liberalization
Executive Summary — Corporate hierarchies are becoming flatter: Spans of control have broadened, and the number of levels within firms has declined. But why? Maria Guadalupe of Columbia University and HBS professor Julie M. Wulf investigate how increased competition in product markets—and, in particular, product market competition resulting from trade liberalization—may be fundamentally altering how decisions are being made. Guadalupe and Wulf also shed light on the possible reasons behind certain organizational choices and on the importance of communication and decision-making processes inside firms. Key concepts include:
- As firms become flatter, they also fundamentally alter how decisions are made.
- Greater international competition following trade liberalization leads to flatter firms.
- When competition increases the value of quick and responsive decision-making, firms eliminate layers to improve the quality and speed of the transmission of information or increase the authority of division managers to become more adaptive to local information.
- U.S. firms in manufacturing industries more exposed to the trade liberalization reduce the number of hierarchical levels, broaden the span of control for the chief executive, and increase total pay and incentive-based pay for division managers.
This paper establishes a causal effect of competition from trade liberalization on various characteristics of organizational design. We exploit a unique panel dataset on firm hierarchies (1986-1999) of large U.S. firms and find that increasing competition leads firms to become flatter, i.e., (i) reduce the number of positions between the CEO and division managers (DM), (ii) increase the number of positions reporting directly to the CEO (span of control), (iii) increase DM total and performance-based pay. The results are generally consistent with the explanation that firms redesign their organizations through a set of complementary choices in response to changes in their environment. 56 pages.