The Creation of A Middle‐Management Level by Entrepreneurial Ventures: Testing Economic Theories of Organizational Design

• Author: Massimo G. Colombo,Luca Grilli
• Date: 01 June 2013
• DOI: http://doi.org/10.1111/jems.12010
• Published date: 01 June 2013

The Creation of a Middle-Management Level by

Entrepreneurial Ventures: Testing Economic

Theories of Organizational Design

MASSIMO G. COLOMBO

Politecnico di Milano

Department of Management, Economics, and Industrial Engineering

Milan Italy

massimo.colombo@polimi.it

LUCA GRILLI

Politecnico di Milano

Department of Management, Economics, and Industrial Engineering

Milan Italy

luca.grilli@polimi.it

Why do some entrepreneurial ventures rapidly switch fromflat organizations composed of owner-

managers and line workers to deeper organizations that also include a middle-management level?

The aim of this paper is to investigate this issue and to test the predictions of different streams

of the theoretical economic literature on organizational design. We use the estimates of survival

data analysis models to examine the determinants of the addition of a middle-management level

to the corporate hierarchy of a large sample of Italian high-tech entrepreneurial ventures. The

econometric results lend support to the view proposed by the “information processing” stream

that the information overload problems engendered by a highly competitive and unpredictable

business environment are key drivers of the creation of a middle-management level. Moreover,

in accordance with the “knowledge hierarchy” literature, the greater the human capital of firms’

owner-managers, the more likely the appointment of a middle manager. Conversely, we fail

to provide evidence consistent with theoretical predictions inspired by the “decentralization of

incentives” stream. Lastly, transaction costs and adverse selection problems in the managerial

labour market are found to have a large negative effect on the likelihood of the appointment of

middle managers.

1. Introduction

Since the seminal work of Simon (1962), scholars in the economics of organization have

described the firm as a hierarchic system: that is, a system that is composed of interrelated

subsystems, each of the latter being, in turn, hierarchic in structure until we reach some

lowest level of elementary subsystem. The depth of the corporate hierarchy measured

We gratefully acknowledge the support of the PRIN fund (contract no. 2006132439_002). We are indebted to

the thoughtful suggestions of the anonymous co-editor and referee that substantially improved the paper.

We also thank Tom ˚

Astebro, Bo Carlsson, Elena Cefis, Annalisa Cristini, Dirk Czarnitzki, Marco Delmastro,

Federico Etro, Riccardo Leoni, Tammy Madsen, Pedro Ortin, Cristina Rossi Lamastra, Christian Serarols,

Erol Taymaz, Sidney Winter, participants in the 2007 EARIE conference, 2008 SMS Conference, 2009 IIOC

Conference, DRUID 2009 Summer Conference, and seminars held at University of Bergamo, UAB, KUL, and

Politecnico di Milano for helpful comments. We are also grateful to Fabio Bertoni for valuable assistance in

running Monte Carlo simulations. Obviously,responsibility for any errors lies solely with the authors.

C2013 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume22, Number 2, Summer 2013, 390–422

The Creation of a Middle-Management Level 391

by the number of hierarchical levels between the top and the bottom of the organization

(i.e., between top managers and line workers) is a crucial characteristic of organizational

design that has attracted a rich stream of theoretical research.1Empirical work in this

area dates back to the pioneer empirical studies of the Aston group in the 1960s (Pugh

et al., 1963,1968,1969; Hickson et al., 1969. See also Child, 1972), but has fallen behind

theoretical developments. Only a few large-scale econometric studies have examined

factors that determine the depth of firms’ corporate hierarchy, focusing attention on

incumbent, generally large sized firms (Delmastro, 2002; Rajan and Wulf, 2006; Wang,

2009; Guadalupe and Wulf, 2010. See Colombo and Delmastro, 2008, chapter 3 for a

review of the early empirical literature).

In this work, we depart from this stream of literature in that we analyse the in-

troduction of a middle-management layer in the corporate hierarchy of owner-managed

entrepreneurial ventures. In particular, we are concerned with two research questions.

First, we investigate “demand side” factors that shape the decision of firms’ owner-

managers to switch from flat organizations composed only of owner-managers and

line workers to deeper ones that also include a middle-management level. Second, pro-

vided that owner-managers are willing to create a middle-management position, we

examine “supply side” factors associated with imperfections in the managerial labor

market that make the implementation of this decision difficult. In the empirical part of

the paper, we analyse the determinants of the introduction of a middle-management

level into the corporate hierarchy of a large sample of Italian high-tech entrepreneurial

ventures. We estimate several survival data analysis models and we consider a large

set of entrepreneur-, firm-, and industry-specific explanatory variables, with the aim of

testing the predictive power of different streams of the theoretical economic literature.

This work originally contributes to the economic literature on organizational de-

sign. As far as we know, this is the first econometric study that focuses attention on

the depth of the corporate hierarchy of entrepreneurial ventures. There are important

advantages to examining how rapidly a middle manager is appointed by an owner-

managed entrepreneurial venture starting from its founding. First, all of these firms

begin operations with a two-layer corporate hierarchy. We analyse factors driving the

addition of one layer (i.e., the switch to a three-layer hierarchy). Hence, the change

in the depth of the corporate hierarchy is the same for all firms and problems engen-

dered by the heterogeneity of the dependent variable in studies that examine incumbent

firms experiencing different types of changes in the depth of the corporate hierarchy,

are avoided. Second, inertial forces that make the depth of the corporate hierarchy path

dependent are weaker at the beginning of firms’ operations (Hannan and Freeman, 1984,

p. 157). Therefore the confounding effect of organizational inertia is more limited here

than in most previous studies on these issues.2The drawback is clearly that our findings

may not be generalizable to other types of firms or to other changes of the depth of the

corporate hierarchy. Lastly,as far as we know, the role of imperfections in the managerial

1. As to our knowledge, Williamson (1967) represents the first theoretical attempt to model the firm as a

hierarchy.

2. Baron et al. (1999a)and(1999b) argue that increases in the managerial intensity of entrepreneurial

ventures, and thus in the depth of their corporate hierarchy, are influenced by the organisational model or

“blueprint” espoused by the founders in creating the new enterprise. This may be a source of path-dependency

in the present study. In the empirical analysis, we consider the characteristics of firms’ founders (i.e., their

number, human capital and managerial and entrepreneurial experience). Unfortunately, we do not have

information on founders’ blueprints. We acknowledge this as a limitation of our study. Our point is that

problems arising from path dependency are less severe here than in previous studies of the depth of firms’

corporate hierarchy.

392 Journal of Economics & Management Strategy

labor market has been neglected in previous studies of the determinants of the depth of

firms’ corporate hierarchy. This is an important gap in the literature. The large costs that

entrepreneurial ventures allegedly incur in recruiting middle managers in comparison

with large established firms mean that the deepening of their corporate hierarchy would

command a great marginal product. In accordance with the insights provided by the re-

source reallocation literature (see Hsieh and Klenow, 2009 for a recent contribution. See

Caselli and Gennaioli, 2005, for a model of inefficiencies in the allocation of managerial

talent based on agency considerations), this deepening, and the associated reallocation

of middle managers from established firms to entrepreneurial ventures may result in a

considerable rise of aggregate total factor productivity. Therefore, understanding when

and how middle-management positions are created by entrepreneurial ventures may

help in removing obstacles in this direction.

This work is also an original addition to the literature on the economics of en-

trepreneurship. With few notable exceptions (Baron et al., 1996,1999a,1999b), organi-

zational design issues relating to the managerial professionalization of entrepreneurial

ventures have been underresearched in this literature. Previous studies indeed have ex-

amined the replacement of founder-CEO by a “professional” top manager (e.g., Boeker

and Karichalil, 2002; Wasserman, 2003) and the organization of the top management

teams of entrepreneurial ventures (e.g., Ucbasaran et al., 2003; Sine and Kirsch, 2006).

However, the creation of a middle-management level and the associated formal delega-

tion of (some) decision authority to a professional salaried manager is a fundamental

transformation of the organization of entrepreneurial ventures that has been neglected

by the extant literature.3Therefore, investigating factors that speed it up is of obvious

interest.

The paper proceeds as follows. In Section 2, we present the theoretical background

and develop a simple model highlighting factors that favor or hinder the creation of

a middle-management level in a two-layer owner-managed entrepreneurial venture.

Then in Section 3, we describe the dataset used in the econometric analysis and provide

some descriptive statistics on the “managerial professionalization” of Italian high-tech

entrepreneurial ventures. In Section 4, we specify the econometric models, introduce

the explanatory variables, and describe the results of the econometric analysis. Some

summarising remarks in Section 5 conclude the paper.

2. Theory

2.1 Theoretical Background

In this work, we consider the transformation of the organization of an owner-managed

firm from a flat hierarchy composed only of two levels (i.e., the owner-manager(s) and

line workers), with all decisions concentrated at the top of the hierarchy,to one that also

includes an intermediate middle-management level (i.e., a three-layer hierarchy). This

transformation involves formal delegation of (some) decision authority to the newly

3. Bertoni et al. (2011) document that the creation of a middle-management level positively influences the

growth rate of Italian high-tech entrepreneurial ventures. Weare not aware of other large scale econometric

studies on this issue. However, both qualitative and quantitative studies in the entrepreneurship literature

suggest that lack of managerial resources representsa key bottleneck for the development o ft his type of firms

(e.g. Greiner 1972) and their managerial professionalisation is likely to result in greater firm performances

(e.g. Davila et al. 2010).