Optimal hierarchies with diverse decision-makers

Abstract

We analyze the optimal decision-making hierarchy in an organization when decision-makers of limited liability have preferences conflicting with the organization’s objective and exert externalities on their counterparts. In a horizontal hierarchy, every decision is made by a different agent. In a vertical hierarchy, one agent is in charge of all decisions. Only this agent is incentivized. This advantage is outweighed if there is a horizontal hierarchy so that the decision-makers’ preferences are close to the organization’s objective with respect to the decision they are in charge of but far from the organization’s objective for the other decisions.