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The Inner Beauty of Firms

R&R at The Journal of Political Economy

This paper studies how the internal organization of firms interacts with labor and product markets. I analyze millions of task assignments across hundreds of salons using data from a software company. I develop a measure of organization complexity, which is the amount of information required to implement a given task assignment. Complexity varies significantly across salons. More complex salons have higher revenues, employees, prices and return customers. Based on these facts, I develop a model where oligopolistic firms with different organization costs choose their internal structure. Complexity is costly, but it allows firms to improve product quality by better matching workers with multidimensional skills to tasks. I characterize the profit-maximizing organization as solving a rational inattention problem. This allows me to identify and estimate the model for Manhattan hair salons. A counterfactual sales tax cut increases task-specialization and therefore the productivity of all workers. A counterfactual increase in the minimum wage increases specialization for minimum wage workers, decreases specialization for non-minimum wage workers, and causes both positive and negative wage spillovers which are not monotone in initial wage. These outcomes occur because internal structure is a choice made by organizationally unique firms.