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This paper studies how adapting the hierarchical organization helps firms alleviate the negative impact of geographic frictions between their establishments on their performance.
We document that multi-establishment firms empirically have more management layers than comparable single-establishment firms. Greater distance between subordinate establishments and headquarters reinforces the effect.
We develop a model to understand the interplay of the number of establishments and the optimal hierarchical organization of a firm. We assume that the knowledge of the CEO is a resource of limited supply for a firm, because the CEO has a limited amount of time. The model shows that adding a layer of management at one establishment increases the efficiency of the use of CEO time in multi-establishment firms and has repercussions for the optimal hierarchical organization of the other establishments. The model mechanism explains both the cross-sectional differences between the organization of single and multi-establishment firms and patterns of their reorganization over time.