The effect of organizational form on information flow and decision quality: Informational cascades in group decision making

This paper identifies a disadvantage to decision making in a team. We show that in some cases available information is lost due to sequential communic ation 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 equilib rium. Cascades never occur in hierarchies that exogenously prevent communic ation. However, when the firm is organized as a hierarchy and the) agents a re given the optimal hierarchical contract, in some cases agents will collu de and sequentially communicate, admitting the possibility of cascades. In these cases, the principals must monitor and enforce the hierarchical proce ss. When monitoring costs exceed the cost of cascades, the team is the opti mal organizational form.