Reducing the Size of Internal Hierarchy: The Case of Multi-Unit Franchising

Successive layers of supervisor–subordinate relationships in organizations often distort information, increase monitoring costs, and lead to a cumulative loss of control. This paper discusses how some organizations can reduce their internal hierarchy by slicing it into two components and substituting the supervisor–subordinate relationship with an independent contract. This substitution allows the organization to shift its lower-level hierarchy to the contractors. These contractors are less likely to indulge in moral hazard, which can further reduce the size of hierarchy required. The paper examines this theory in the domain of multi-unit franchising and tests the hypotheses with a longitudinal data set.

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► Slice a hierarchy into two components and reunite them with an independent contract.
► This shifts the lower-level hierarchy of organization to multiple contractors.
► Because of incentive compatibility, these contractors need less monitoring.
► This further reduces the size of required internal hierarchy.
► New organization has two hierarchical components joined with an independent contract.