Faculty of Economics and Business Administration Publications Database

Influence Costs and Hierarchy

Müller, Holger M.
Wärneryd, Karl
Volume: 6
Number: 2
Pages: 177 - 197
Month: July
ISSN-Print: 1435-6104
Link External Source: Online Version
Year: 2005
Keywords: Hierarchies; Influence activities; Internal capital markets
Abstract: In an internal capital market, individual departments may compete for a share of the firm’s budget by engaging in wasteful influence activities. We show that firms with more levels of hierarchy may experience lower influence costs than less hierarchical firms, even though the former provide more opportunities for exerting influence. The unique influence-cost minimizing hierarchy is strongly asymmetric. With a linear production technology this is also the optimal hierarchy. If individual departments have different productivities, however, and the production technology exhibits decreasing returns to scale, a symmetric hierarchy that does not minimize influence costs may be optimal.