Organizing to adapt and compete

Abstract

We examine the relationship between the organization of a multi-divisional firm and its ability to adapt production decisions to changes in the environment. We show that even if lower-level manag-ers have superior information about local conditions, and incentive conflicts are negligible, a centralized organization can be better at adapting to local information than a decentralized one. As a result, and in contrast to what is commonly argued, an increase in product market competition that makes adaptation more important can favor centralization rather than decentralization. (JEL D21, D23, F23, L22) The organization theorist Chester Barnard and the economist Friedrich Hayek shared the view that the “economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place ” (Hayek 1945, 524). But whereas Hayek viewed adaptation as an autonomous process, undertaken by individual economic actors, Barnard (1938) stressed the ability of organizations to engage in what Oliver Williamson (1996, 2002) calls “coordinated adaptation.” Williamson (1996, 103), referring to Barnard and challenging Hayek, argues that: