Firm decentralization around the world

1. Firm decentralization around the world Nick Bloom (Stanford Economics) John Van Reenen (Stanford GSB/LSE) Lecture 8: February 2010 1

2. Summary of last lecture on hospitals, school and retail management • Huge variation in management practices seems common to every sector we have studied to date • The very same practices around monitoring, targets and incentives always associated with superior performance • Demonstrates there are basic management best practices, with the grid identifying a core set of these • Grid plus data useful tool for change management in that provides evidence base on key practices

3. What is decentralization? • Measurement and stylized facts • Determinants of decentralization • Firm Performance and decentralization

4. What is decentralization? • One aspect of firm organization - how power and decision making are distributed • Unlike basic management practices no typical “good” and “bad” – just different styles which tend to vary by country • Why should you care: • Key in designing your business or advising others • Changing over time, generating broader economic effects, like increased inequality and worker empowerment

5. Are things really changing? "Globalization and the arrival of the information economy have rapidly demolished all the old precepts. The management of global companies, which must innovate simultaneously and speed information through horizontal globe-spanning networks, has become a daunting challenge. Old, rigid hierarchies are out ...." Business Week The 21st Century Corporation, cover story August 21-28, 2000.

6. Evidence is limited, but appears yes, firms are decentralizing Delayering – Number of positions reporting to CEO Source: Rajan and Wulf, 2006, 300+ large US corporations

7. Formal vs. Real Authority • Formal authority in the organization chart (“organogram”) • E.g. Profit centres vs. cost/sales centres • Real authority • How things actually get done. Power • http://www.youtube.com/watch?v=5FRVvjGL2C0 • Can be different across different types of decisions • e.g. pricing, products and M&A

8. Real authority models: Centralized http://www.youtube.com/watch?v=wBIov_CSqyI&feature=related

9. Real authority models: Decentralized e.g. Universities, but academics generally pretty inefficient

10. What is decentralization? • Measurement and stylized facts • Determinants of decentralization • Firm Performance and decentralization

11. Central HQ (New York Site) Plant (Albany Site) Example A: Domestic Firm 2 Sites, Single Plant D, Decentralization

12. Central HQ (New York Site) Plant 1 (Buffalo Site) Plant 2 (Albany Site) Example B: US Domestic Firm Multi-Site, Multi-Plants D3 D1 D2 Plant 3 (Scranton Site)

13. The Decentralization Survey Page

14. Our empirical decentralization measure • Main measure averages the z-score (scores normalized to mean 0, standard-deviation 1) of each variable: • Hiring senior employees (discrete, 1 to 5) • Maximum Capital expenditure (continuous, in $) • Introduction of new products (discrete, 1 to 5) • Sales and marketing (discrete, 1 to 5)

15. Decentralization varies heavily across countries • Most centralized • Asia • Southern Europe • Least centralized • Scandinavian countries • Anglo-Saxon countries Decentralization measure

16. Decentralization also varies across firms Decentralization measure (higher number is more decentralized)

17. External validation – decentralization over time • Only prior firm decentralization measure to cross-check against we are aware of is from Hofstede • Surveyed c.100,000 IBM employees across 50 countries during the 1970s & 1980s • Questions on management style (autocractic/paternalistic or consultative) and preferences for delegation • Combined into Power Distance index (1-100), low means limited (preference for) delegation

18. ‘Power distance’ measures from 1970s & 1980s matches our 2000s decentralization data quite well Decentralization Correlation= 0.80 Power distance

19. Fiscal decentralization (whether Governments are centrally run) looks similar – so something cultural? Firm Decentralization Correlation= 0.83 Fiscal Decentralization(Arzaghi and Henderson, 2005)

20. Decentralization also varies across ownership types – with founder and government firms centralized Decentralization measure

21. What is decentralization? • Measurement and Stylized facts • Theories & Determinants of decentralization • Firm Performance and decentralization

22. What do you think are the benefits and costs of decentralization?

23. Some Benefits of Decentralization • Saves on costs of communication and information transfer • Improves swiftness of reacting to market changes [e.g. because of less specialization, more multi-tasking] • Increase in employee involvement, so possibly more job satisfaction

24. Some Costs of Decentralization • More “mistakes” (e.g. co-ordination in price setting) • Harder to exploit returns to scale/specialization – i.e. repetition of same activities across different divisions • More stress from control?

25. Factors affecting Decentralization • Technological • Economic • Cultural/Legal

26. Technological Factors affecting Decentralization • Complexity: Size, Product and Multinational status • Learning: Age and Proximity to technological frontier • ICT: Information costs and Communication costs

27. Complexity: Larger Firms are more decentralized Number of employees in the firm

28. Complexity: Multinationals (even controlling for size) are more decentralized

29. Learning: Younger firms are more decentralized 29

30. Learning: More technologically advanced firms (i.e. close to frontier) more likely to be decentralized

31. ICT: Decentralization and the use of ICT • Information technology (IT) increase decentralization • Communications technology (CT) decreaseas decentralization Notes: Controls are SIC3 dummies, country dummies, noise controls (interviewer dummies Interviewee tenure and seniority, etc.), public listing, CEO onsite, plant size,

32. Factors affecting Decentralization • Technological • Economic • Cultural/Legal

33. Economic Factors affecting Decentralization • Competition • information: Improves the value of timely responses to local conditions • incentives: Lower risk of manager abusing autonomy as incentives more aligned with firm • Skill: more able workers better at coping with responsibility

34. Competition: Firms facing more competition are more decentralized Notes: Other controls are SIC3 dummies, 12 country dummies, noise controls (interviewer dummies Interviewee tenure and seniority, etc.), public listing, CEO onsite, plant size,

35. Skill: Firms with more skilled workers are more decentralized Proportion of employees with a college degree

36. Legal and Cultural Factors affecting Decentralization • Trust • In high trust areas (e.g. Sweden) managers likely to be trusted to carry out more activities • Rule of Law • In good rule of law areas (e.g. US) top management less worried about theft by middle management • Religion • Evidence that firms from areas with more centralized religions tend to be more centralized (causal?)

37. Trust and decentralization • How to measure trust? World Value Survey has question: “Generally speaking, would you say that most people can be trusted or that you can’t be too careful in dealing with people?” • Trust by region of the country defined as % of people answering “yes” to first part of the trust question • Experiments show this question linked with trust/trusting behavior (Glaeser et al, 2000, Sapienza et al, 2007)

38. Trust by country (means and regional spreads) The graph shows median level of trust. The vertical bars denote minimum and maximum levels.

39. Trust, rule of law and decentralization Notes: Other controls are SIC3 dummies, noise controls (interviewer dummies Interviewee tenure and seniority, etc.), public listing, CEO onsite, plant size, competition

40. Also look at multinationals as another test of trust • Could worry about bias due to trust proxying for other country/regional variables • So look at affiliates of foreign multinationals and investigate whether trust in their home country also matters • Bilateral trust: (on average) how much do people in the multinational’s home country trust people in the country where the subsidiary is located (Eurobarometer Survey)

41. Central HQ (New York Site) Plant (Phoenix Site) Example A: Domestic Firm 2 Sites, Single Plant D, Decentralization

42. Example D Japanese MNE Global HQ (Tokyo Site) Do not observe D French CHQ (Paris Site) Sweden CHQ (Stockholm Site) Observe D Observe D Plant 1 (Lund Site) Plant 2 (Lyon Site)

43. Decentralization and trust in multinational firms

44. What is decentralization? • Measurement and Stylized facts • Determinants of decentralization • Firm Performance and decentralization

45. Does decentralization matter for performance? • Short run: generally depends on firms circumstances (e.g. country, industry and technology) • Short run: one recent factor that has been rapidly affecting this is IT. Evidence that impact of IT on productivity much higher in better managed and more decentralized firms • Long run: to be large you need some decentralization, so key for growth (Penrose 1959 and Chandler 1962)

46. Productivity growth and IT • “High Org” = more decentralized • IT and decentralization appear complementary

47. Wrap-up • Decentralization varies heavily by country and ownership • Northern European and US firms decentralized, and Southern European and Asian being centralized • Founder, family and government very centralized • Factors driving this appear to be both economic – competition, technology and skills – but also cultural around trust, rule-of-law and even religion • In short-run decentralization is a choice variable depending on circumstances, but necessary for growth in long-run