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The Effect of Organizational form on Information Flow and Decision Quality: Informational Cascades in Group Decision Making

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  • Steve L. Slezak
  • Naveen Khanna

Abstract

This paper identifies a disadvantage to decision making in a team. We show that in some cases available information is lost due to sequential communication that results in informational cascades. Although incentive contracts exist that prevent cascades, in some cases these contracts do not maximize shareholders' expected residual value and cascades are tolerated in equilibrium. Cascades never occur in hierarchies that exogenously prevent communication. However, when the firm is organized as a hierarchy (and the agents are given the optimal hierarchical contract), in some cases agents will collude and sequentially communicate, admitting the possibility of cascades. In these cases, the principals must monitor and enforce the hierarchical process. When monitoring costs exceed the cost of cascades, the team is the optimal organizational form.

Suggested Citation

  • Steve L. Slezak & Naveen Khanna, 2000. "The Effect of Organizational form on Information Flow and Decision Quality: Informational Cascades in Group Decision Making," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 9(1), pages 115-156, March.
    • Handle: RePEc:bla:jemstr:v:9:y:2000:i:1:p:115-156
    DOI: 10.1111/j.1430-9134.2000.00115.x
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    References listed on IDEAS

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    Cited by:

    1. Renee B. Adams & Benjamin E. Hermalin & Michael S. Weisbach, 2010. "The Role of Boards of Directors in Corporate Governance: A Conceptual Framework and Survey," Journal of Economic Literature, American Economic Association, vol. 48(1), pages 58-107, March.
    2. David Hirshleifer & Siew Hong Teoh, 2003. "Herd Behaviour and Cascading in Capital Markets: a Review and Synthesis," European Financial Management, European Financial Management Association, vol. 9(1), pages 25-66, March.
    3. Pegaret Pichler, 2004. "Optimal Contracts for Teams of Money Managers," Econometric Society 2004 North American Winter Meetings 495, Econometric Society.

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