Trade in tasks and the organization of firms
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Trade in Tasks and the Organization of Firms. Dalia Marin, Jan Schymik, Alexander Tarasov University of Munich CESifo Global Economy Conference Munich May 2014 . The Changing Nature of Organizations and International Trade.

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Trade in tasks and the organization of firms

Trade in Tasks and the Organization of Firms

Dalia Marin, Jan Schymik, Alexander Tarasov

University ofMunich

CESifo Global Economy Conference

Munich May 2014


The changing nature of organizations and international trade

The Changing Nature of Organizations and International Trade

  • Shifting international boundariesofthe firm trade in tasksoroffshoring(Hummels et al 2001,

    Marin 2006)

  • Rise in CEO Pay in industrialized countries

  • Move todecentralizedmanagement in corporations

    (Rajan and Wulf (2006), Marin (2008), Marin andVerdier (2010), Bloom, Sadun, van Reenen(2010)


Question

Question

What is the connection between

trade in tasks,

decentralized management and

the rise in CEO pay?


Literature on trade and organizations

Literature on Trade and Organizations

  • Marin andVerdier (MV) (2008, 2010), Caliendoand Rossi-Hansberg (2012): North-North-trade in final goodsleadstomoredecentralizedmanagement

  • Marin andVerdier(2012): North-South trade in final goodsleadsto a ‚war fortalent‘ andtotheemergenceofthetalent firm

  • Grossman and Rossi-Hansberg (GRH) (2008): Trade in tasks (offshoring) mayleadto a rise in wages in rich countries


Contribution of this paper

Contribution of this paper

We incorporate trade in tasks of GRH (2008)

into a

small open economy version of the theory of firm organization of MV (2012)

to examine

how offshoring affects decentralized management and CEO pay in firms


By doing so

By doing so…

we show that offshoring of production tasks

  • leads to decentralized management in firms in an open economy

  • leads to improved competitiveness in Northern firms as the productivity gains from offshoring translate into gains in market shares


By doing so1

By doing so …

we show that offshoring of managerial tasks

  • relaxes the constraint on managers (the labor market effect) lowering CEO wages

  • but toughens competition (the war for talent effect) increasing CEO wages.

  • leads to an unambiguous rise in CEO wages in sufficiently open economies


Firm survey of offshoring firms

Firm Survey of Offshoring Firms

We conducted a firms survey

among of 660 multinational firms in Austria and Germany with 2200 affiliates in Eastern Europe during 1990 – 2001.

80 percent of German investments in EE

100 percent of Austrian investments in EE


Trade in tasks and the organization of firms

The Model


A small open economy

A Small Open Economy

Two sectors:

X-sector, differentiated goods,

monopolistic competition

Y-sector, homogenous goods,

perfect competition

Two factors of production:

human capital (skilled managers)

labor (production workers)

In the X-sector firms choose a firm organization


Three firm organizations

Three Firm Organizations

P-Organization:

P has formal authority in the firm

P runs the firm with A’s cooperation

A-Organization:

P delegates formal authority to A

A runs the firm with P’s cooperation

O-Organization:

P runs the firm without A’s cooperation


Firm organization

Firm Organization

We consider a firm with a simple hierarchy

CEO (P) hires a skilled manager (A) to run the firm and workers to produce, P and A look for projects for the firm

There is a conflict of interest between P and A

Payoffs of P and A depend on who’s project is implemented


Trade off between control and initiative

Trade-Off between Control and Initiative

P supervises the more

the larger are her stakes (the larger are

profits)

A has more initiative

the lower P’s probability of intervention

Cost of hierarchies: loss of initiative


The choice of decentralized management

The Choice of Decentralized Management

From Marin and Verdier (2012) we get

Firms will choose decentralized management (A-organization) at an intermediate level of profits

At low and high profits there is no trade-off between control and initiative, hence, firms choose control (centralized management)


Trade in tasks and the organization of firms

Next step:

Endogenizeprofits:

small open economywith

monopolisticcompetition


Product market and trade environment

Product Market and Trade Environment

Consumer preferencesoverthetwogoods

X and Y are

with

Ω, Ωmsetofdomesticandforeignvarieties


Product market and trade environment1

Product Market and Trade Environment

In a small open economy (SOE): thenumberandprices

offoreignvarietiesaregiven, foreigndemandfor

domesticvarietiesisexogenous

Prices in the SMO are

n*numberofforeignvarieties, pmpriceofimportedvariety

n*(pm)1-σ = IMlevelofimportpenetration, exogenous


Offshoring of productiontasks

OffshoringofProductionTasks

Productionissector X involves a continuumoftasksofmeasure 1. Performingeachtaskrequiresc(i)unitsoflabor. Itis profitable to offshore taskj, j(0,1)if

, t(j)costofoffshoring

Marginal costsofthe firm:

withtheproductivitygainsfromoffshoring

ZX withIXthenumberoftasksoffshored. IX = 0 ZX = 1

Profits of a firm i

cB

B


Factor markets

Factor Markets

Factordemanddepends on theequilibriumorganizationP,A,Oand on theorganizational mix offirms.

k=Pforlowprofits

k=Afor intermediate profits k=Ofor high profits


Equilibrium

Equilibrium


Intuition

Intuition

Upward sloping HH curve:

B/w increases, excess demand for managers, q/w has to rise

q/w increases, few firms are looking for a manager, excess supply of managers, number of firms n has to rise which happens when B/w increases

Upward sloping EE curve (war for talent curve):

As B/w rises, firm entry, number of firms is fixed by H, competition for managers, q/w rises


Trade in tasks and the organization of firms

How are changes in openness affecting the

equilibrium?


Figure 2 an increase in openness

Figure 2 An increase in openness


Trade in tasks and the organization of firms

How are changes in

offshoring of productiontasks affecting the level of decentralized management?


Offshoring of production tasks

Offshoring of Production Tasks


Intuition1

Intuition

Two opposing effects:

Zx  wc(i)/Zx profits rise  (productivity effect)

Other domestic firms become more productive as well, revenues  and profits  (revenue effect)

In an open economy the productivity effect dominates the revenue effect and B/w rises


Effect on organization

Effect on Organization

When profits rise, P starts to monitor more potentially destroying A’s initiative,

When profits rise sufficiently, the trade-off between control and initiative favors initiative, P delegates authority to the skilled manager, decentralized management


Trade in tasks and the organization of firms

Empirics


Measuring decentralized management

Measuring Decentralized Management

‘Who decides in your company over the

following decisions…..?

Please rank between 1 … 5’

1 taken at headquarters (CEO)

5 taken by the divisional manager


Level of decentralization of corporate decisions

Level of Decentralization of Corporate Decisions


Measuring offshoring of production tasks

Measuring Offshoring of Production Tasks

intra-firm imports from all subsidiaries in percent of parent sales

instrument for offshoring of production tasks:

‘standardized foreign input’


Prediction

Prediction

Prediction 1: In a cross section of firms in an economy open to trade, multinational firms will have more decentralized management, when they are offshoring more production tasks to low wage countries.


Economic magnitude

Economic Magnitude

Offshoring firms are 33.4 percent

more decentralized

than non-offshoring firms

when we instrument offshoring with ‘standardized foreign input’.


Offshoring of managerial tasks

Offshoring of Managerial Tasks

Managers perform a continuum of tasks of measure 1 requiring one unit of managerial labor.

Foreign managers do not receive authority in the firm.

Fraction of managerial tasks offshored is exogenous and given by IS.

Itis profitable to offshore managerialtasksif

q > q*

q, q*managerwages at homeandabroad

q(1- IS) + q* IS costofmarketentry


Offshoring of managerial tasks1

Offshoring of Managerial Tasks

Proposition 3:In the P-equilibrium, there exists a cutoff level of openness of the economy denoted by IM, such that for IM > IMp: B/w and q/w are increasing in Is; and for IM < IMp: B/w is declining in Is, while the impact of Is on q/w is ambiguous.


Offshoring of managerial tasks im im p

Offshoring of Managerial Tasks: IM > IMP


Offshoring of managerial tasks im im p1

Offshoring of Managerial Tasks: IM < IMP


Intuition2

Intuition

Three effects of a rise in Is:

war for talent effect: Is  cost of market entry   firm entry, fix H  q/w and B/w

labor market effect: Is  demand for skilled managers q/w 

competition effect: more firms find a manager n  competition  B/w


Overall effect on b w

Overall Effect on B/w

depends on the level of openness IM

large openness IM > IMp: positive war for talent effect dominates the competition effect, profits rise with Is

small openness IM < IMp: competition effect dominates the war for talent effect, profits decline with Is


Overall effect on q w

Overall effect on q/w

depends on the level of openness:

large openness IM > IMp: war for talent effect pushing up q/w dominates the labor demand effect pushing down q/w,as a result q/w 

small openness IM < IMp: labor demand effect large (large shift in HH) but war for talent effect also large (steeper HH), effect on q/w 


Trade in tasks and the organization of firms

Empirics


Measuring offshoring of managerial tasks

Measuring Offshoring of Managerial Tasks

‘How many managers of your parent company have been sent to the affiliate firm?’

offshoring of managerial tasks = 1 – managers sent

in 57 percent of all direct investments at least one managers has been offshored

on average 2.63 managers are offshored per investment project

max 39 managers offshored


Measuring q w

Measuring q/w

Total compensation per board member of the firm (Kienbaum management consultancy) relative to average wage of the firm (firm survey)


Prediction1

Prediction

Prediction 2: In a cross section of firms in sectors sufficiently open to trade, multinational firms will have more decentralized management when they are offshoring managerial tasks to low wage countries.


Economic magnitude1

Economic Magnitude

An increase in the sample mean of the fraction of managers offshored (1.48) reduces the level of decentralized management by 3.1 percent but increases the level of decentralized management by 4 percent in industries with a level of openness above the 25th percentile of the openness distribution.


Prediction2

Prediction

Prediction 3:In a cross section of firms exposed to international trade, multinational firms will pay their CEOs lower wages when they are offshoring managerial tasks to low wage countries and they will pay their CEOs higher wages when the number of firms in the domestic market increases.


Economic magnitude2

Economic Magnitude

One additional manager offshored lowers CEO pay relative to workers by 6.9 percent (labor market effect).

This implies that relative CEO compensation is lower by 13 – 18 percent due to managerial offshoring.

One additional manager offshored allows one additional firm to enter which increases relative CEO pay by 2 percent (war for talent effect).


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