Internal Organization of the Firm

Abstract Management decisions about the boundary (size) of the firm, internal organization of the firm, and the internal systems for aligning incentives of all stakeholders of the firm are critical to enable the firm to create the most value given its resources and market opportunities. Internal organization defines who makes which decisions, who controls which information, and whose goals are or are not aligned with the objectives of the firm. Within any organizational structure there is a trade‐off between the amount of information in each business unit and the need for coordinated decisions across units. As firms increase in scale, per unit costs decrease due to economies of scale and scope. On the other hand, as the firm grows in size multiple principal‐agent problems arise which result in residual loss. Internal organization of firms falls into four basic structures: the Unitary functional structure (or U‐form), the multidivisional structure (or the M‐form), the matrix structure and the network structure.