Complex Hierarchy: The Employment Relation Extended

A chronic problem with which economic organization must contend is how to harness opportunism. For the reasons given in Chapter 4, indi-vidual workers acquire monopoly powers, in some degree, over jobs. Also, as the above discussion of the inside contracting system reveals, the same holds true for managers of functional departments. While individual interests are promoted by exercising these powers for private gain, the system as a whole incurs additional costs and may be rendered nonviable.

1. General

A systems solution that transforms the relation between the parties from one of qualified antagonism to more complete cooperation is clearly indicated. Extending the employment relation, which had the effect of curbing opportunistic behavior among workers in the simple hierarchy, to include department managers serves to promote such an outcome. The firm offers managers job security and an internal equity system, in return for which managers agree to being evaluated in terms of their contribution to the system as a whole — as revealed in part by their attitude of cooperation.

The argument here really parallels that of Chapter 4 in most essential respects. What one wants to devise is a contractual relation that promises fair (competitive) returns, promotes adaptive efficiency, and is relatively satisfying in terms of the involvement experience. Inside contracting is deficient in the first two respects and may pose problems in the third. Shifting inside contractors from a quasi-autonomous bargaining status to an employment relation has advantages in the first two —and in possibly all three —respects.

Several things occur when the inside contractor becomes a manager. First, he no longer has claims on a semi-independent profit stream. Second, his operations become subject to an internal audit. His incentives to engage in opportunistic behavior are attenuated for the first of these reasons, and his information impactedness advantage is reduced by the second.20 More generally, he becomes a member of a team, and, as a member of the team, becomes subject to a different set of expectations regarding his relation to the whole than is the case when quasi-autonomy is preserved and self- seeking is expected. Informal group influences, of the sorts described in the preceding chapters, are brought more systematically to bear when behavior contrary to the interests of the firm occurs.

In addition to being audited and evaluated, managers are subject to a relatively refined internal reward and compliance machinery. While a more complete discussion of the operation of the internal compliance system is given in Chapter 8, it is worthwhile to observe here that the expectation that employment terms and prospects are subject to fine tuning adjustments serves to promote functional and check dysfunctional behavior.

2. Some Specifics

The general advantages of an employment relation (in contractual in- completeness respects, for dispute settling purposes, and in communication respects) have been examined in earlier chapters. Consider, however, the specific advantages of an employment relation in each of these three respects as they bear expressly on department managers.


Internal organization encourages investments in organizational in- frastructure in ways that permit efficient information-processing. Interfaces can be brought into correspondence by design. Performance programs that provide for assured coordination between the parts may be devised. [As March and Simon observe: “Situations in which a relatively simple stimulus sets off an elaborate program of activity without any apparent interval of search, problem-solving, or choice are not rare Most behavior, and particularly most behavior in organizations, is governed by performance programs” (1958, pp. 141-142).]

One might argue that, in principle, these very same performance pro- grams might be introduced into a sales contract. Several things discourage this, however. First, the typical performance program is incomplete. Execution requires judgment, which is to say that consummate rather than perfunctory cooperation is expected. The manager and at least some of his subordinates are expected to exercise discretion in a constructive fashion. They are rewarded in turn by performing in a functional manner, though not in a transaction-specific fashion. Were similar gaps to appear in a sales contract, the buyer would be exposed to considerable risk of supplier opportunism. (Attempts, moreover, to negotiate and implement exhaustively complete performance programs that bring the interfaces between two independent organizations into design correspondence are discouraged by all of the factors that make complex contingent sales contracts expensive instruments to write and execute.)

Also, there is a problem of adapting the program (contract) appropriately through time. Internal program elaboration is a natural result of experience and is a manifestation of organizational learning. It occurs costlessly as a by- product of the firm’s operations. Such changes are made in a contract, however, only as a result of negotiation. Haggling is commonly to be expected.

2.2. FIAT

Pure authority relationships, to be sure, are “analytical abstractions that are rarely found, if at all, in concrete situations. [But] this rarity makes the analytical distinction between them and other forms of influence no less important” (Blau and Scott, 1962, p. 3). Or, as Barnard observes, in referring to the “fiction” of authority: “This fiction merely establishes a presumption among individuals in favor of the acceptability of [hierarchical] orders” (1962, p.170). He nevertheless insists that “Either as a superior officer or as a subordinate, … I know nothing more ‘real’ than authority” (1962, p. 170, n. 5).

Whatever the case, assessing the comparative efficiency of alternative modes of organization requires that the conflict resolution machinery be examined. An authoritative order is usually a more efficient way to settle minor conflicts (for instance, differences of interpretation) than is haggling or litigation. Frequently such differences are not matters of special importance to managers and are therefore resolved administratively without incurring resistance (Whinston, 1964, pp. 410-414). To the extent, however, that interfirm profitability effects would be involved if the transactions in question were to be organized across a market, similar interorganizational conflicts can be settled by fiat only rarely, if at all. For one thing, it would require the parties to agree on an impartial arbitrator, and the agreement itself may be costly to secure.59 In addition, outside arbitration, as compared with inside conflict resolution, has a less easy (more costly) access to the facts and tends to (1) employ restrictive rules of evidence, (2) consider the issues narrowly, from the point of view of what is actionable rather than in terms of what really is at stake, (3) cast the problem in the context of legal precedent for the class of cases to which it is related rather than in firm- specific terms, and (4) favor equity in relation to efficiency considerations where these goals are in conflict. Altogether one concludes that, in dispute settling respects at least, internal organization is preferred over market mediation for activities for which instrumental disputes frequently arise.


Among the reasons why hierarchical forms of organization have advan- tages for communication purposes are that they permit status to be assigned to roles in a determinate way.60 Arrow contends that authority is viable if it is the focus of convergent expectations: “An individual obeys authority because he expects others will obey it” (1974, p. 72). For functional roles to be influential in this way requires that authority be visible.

Similarly, Barnard observes that “a system of organization communica- tion, in order that it may operate with sufficient accuracy and rapidity, has to be so designed that it may easily and quickly be assured that particular communications are (a) authentic, (b) authoritative, and (c) intelligible” ( 1946, p. 64). A status system facilitates effective communication in each of these respects (1946, pp. 67, 80). Internal organization, having access to a more finely graded status system than the market, thus may be judged to enjoy a communication advantage, in relation to the market, in the degree to which the needs for authenticity, authoritativeness, and intelligibility are especially great, ceteris paribus. The previously described adaptational advantages of internal organization as a response to uncertainty are thus reinforced by considering the importance of status systems to effective communication and by noting that the efficacy of status systems varies by organizational mode.

Source: Williamson Oliver E. (1975), Markets and hierarchies: Analysis and antitrust implications, A Study in the Economics of Internal Organization, The Free Press.

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