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The Role of Organizational Structure:
Between Hierarchy and Specialization
Massimo Massa * Lei Zhang **

* Department of Finance, INSEAD, Boulevard de Constance, 77300 Fontainebleau France, Tel: +33-160724481, Email: massimo.massa@insead.edu ** Division of Banking and Finance, Nanyang Business School, 50 Nanyang Avenue, 639798 Singapore. Tel: +65-81824202, Email: zhangl@ntu.edu.sg

The Role of Organizational Structure:
Between Hierarchy and Specialization

Abstract:
We study how organizational complexity affects managerial behavior, breaking it down into vertical hierarchy and degree of specialization. We exploit a novel dataset on the organizational structure of the US asset management industry. We show that more hierarchical structures reduce the incentive to collect soft information by investing less in closely-located firms. This reduces portfolio concentration and performance and increases herding. In contrast, a higher degree of specializations and variety of competences makes asset managers provide more unique trading strategies and herd less with each other. Changes in fund structure quickly find their way into the behavior of fund managers.

JEL classification: G23, G30, G32 Keywords: organizational structure, hierarchy, specialization, mutual funds, performance, herding, proximity investment.

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The Role of Organizational Structure:
Between Hierarchy and Specialization

Abstract:
We study how organizational complexity affects managerial behavior, breaking it down into vertical hierarchy and degree of specialization. We exploit a novel dataset on the organizational structure of the US asset management industry. We show that more hierarchical structures reduce the incentive to collect soft information by investing less in closely-located firms. This reduces portfolio concentration and performance and increases herding. In contrast, a higher degree of specializations and variety of competences makes asset managers provide more unique trading strategies and herd less with each other. Changes in fund structure quickly find their way into the behavior of fund managers.

JEL classification: G23, G30, G32 Keywords: organizational structure, hierarchy, specialization, mutual funds, performance, herding, proximity investment.

Introduction
The literature on the theory of organizations has extensively studied the way the organizational structure affects the behavior of the members of the organization. However, very little empirical evidence exists on what part of the organizational structure matters and what is its main channel of influence. There are two alternative intuitions: on the one hand, the vertical chain of control provides the main differentiating effect. On the other hand, it is the degree of different specialties among the members that mostly matters. The vertical chain is related to and defines the level of “bureaucracy” within the organization. A vertical structure creates a chain of command that relates the HQ to the lowest level business units, through a series of intermediate layers that take care of executing HQ directives at a more disaggregated level. The allocation of authority and tasks to the managers of the intermediate layers in the organization affects both the incentive of the managers as well as the ability of the HQ to monitor them. At the same time, the degree of specialization matters as well. The fact that the members have different and specialistic competences affects the incentives. For example, the fact that managers share the same qualifications improves the “congruence” (Dessein, 2002). This should be reflected in higher delegation and ameliorated coordination. The lower informational asymmetry may help the decision-making process and help to generate more information and provide more expertise. On the other hand, different qualifications may make it more difficult to reach coordination. The fact that the degree of specialization affects the ability of HQ to...
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