How close a company works at the cutting edge of an industry affects how much it delegates authority. (Reuters photo by Stephen Lam)

Running a company in an industry driven by fast-paced innovation typically requires putting decision-making powers in the hands of employees at various levels, not just top-level managers.

“If your industry is very innovative and your customer and product are changing all the time, it’s very hard to have things centralized,” says Nicholas Bloom, who teaches at Stanford Graduate School of Business. Bloom, co-author of “Incomplete Contracts and the Internal Organization of Firms,” published last year by the National Bureau of Economic Research, examined various ways in which firms create flexible structures, as well as why they do it.

The paper, co-authored with Philippe Aghion of Harvard University and John Van Reenen of the London School of Economics, finds that the way a company delegates authority varies by geography and reflects its tolerance for risk. “American firms are pretty decentralized and very flat, since Americans through their very nature like self-determination,” says Bloom. “It links to how comfortable people are with risk-taking. If you’re not comfortable with risk-taking, you probably want guidance, which is what you get in a more centralized firm.” While firms in Northern Europe are like U.S. firms — comparatively flat — those in Southern Europe, South America, and Asia tend to be more hierarchical. Therefore, firms aiming to expand beyond their home continent need to be aware that homegrown decision-making practices might not fly elsewhere, he says.

How close a company works at the cutting edge of an industry also affects how it delegates authority. The managers of a factory that mass produces a single product has little need to delegate authority since the highest priority is keeping quality consistent and production costs low. At the other extreme, in Silicon Valley “you’re at the technological frontier and people need the ability to respond quickly,” says Bloom. “If you really want to innovate, it seems that decentralization generates experimentation. You want to discover what works and what doesn’t.”

If you want a firm full of PhD’s but have a command-and-control system, it won’t work. Nicholas Bloom, professor of economics by courtesy

Companies in fast-moving industries are likely to decentralize also because their highly educated employees typically expect a large degree of self-direction in their jobs. “If you’re, for example, Google, Intel, or GlaxoSmithKline, you’re going to want bright employees” — likely college graduates who value self-determination, says Bloom. “If you want a firm full of Ph.D.’s but have a command-and-control system, it won’t work.”

Information technology (the IT in ICT) is another big decentralizer because it allows information to be spread quickly throughout an organization. For example, prior to the use of electronic medical records and online databases of drugs and diagnoses, nurses stuck to basic medical tasks. With access to medical information on computer terminals and mobile devices, nurses can now provide certain treatment without requiring patients to see a physician. “If people at the bottom of an organization are informed, they can make decisions on their own,” Bloom says.

On the other hand, communications technology (the CT in ICT) can have the opposite effect and concentrate authority. Email, text messages, and mobile phones make it so easy to interact that employees can readily defer decisions to higher-ups. “If you can communicate perfectly, with any big issue, you just pick up the phone and talk to the guy back home,” says Bloom. “For example, foreign ambassadors used to be powerful people making major decisions, but with modern communication those decisions are taken centrally, and they’ve lost that power.”

Nicholas Bloom is a professor of economics by courtesy at Stanford GSB, and a professor of economics at Stanford University's School of Humanities and Sciences. His research interests focus on measuring and explaining management practices across firms and countries.