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A Theory of Firms as Competing Organizations with Evidence from the Beauty Industry

Abstract

This paper studies the interaction between competition and the internal organization of firms using a new model and novel data. In the model, firms with different organizational efficiency choose their entire organization structure, including who to hire and the task-content of each worker’s job, in order to compete in a differentiated product market. The model illustrates that firms face a quality-wage-complexity trade-off when choosing their organizational structure. I show the model features a unique equilibrium under testable condition, can be solved using a globally convergent algorithm and can be identified using a measure of organizational complexity. I use the model to study the beauty industry. Millions of task assignments across competing hair salons illustrate that organizational complexity is positively correlated with firm revenue, employment, and labor, consistent with the model. I estimate the model, and use it to study the impact of a counterfactual convergence of management practices and a counterfactual sales tax on hair services in Los Angeles.