Organizational Structure, Aggregation of Performance Measures, and Incentives

In this paper, we analyze the impact of organizational structure on incentives within a LEN-framework with agents on three hierarchical levels (bottom, middle, top), where the performance measures used for incentive design originate at the bottom-level. Previous literature has shown that with such disaggregated measures, the impact of organizational structure on incentives is limited to midlevel agents. In contrast, we show that with fully aggregated performance measures, organizational structure and incentives are independent. Furthermore, considering partially aggregated measures extends the impact of organizational structure on incentives to all hierarchical levels. The key to our results is that organizational structure affects the quality of aggregated performance measures, whereas the accounting system determines the extent of aggregation. We find that, frequently, the optimal organizational structure on the firm-level is detrimental to at least one hierarchical level. Based on this result we provide a rationale for the empirical lack of the theoretically well established trade-off between risk and incentives