We model a firm in an institutional market setting, consisting of a production technology and its governance. The governance consists of a hierarchical firm structure, a cost efficiency parameter,and an internal pay system. The depth of the firm is determined by profit maximization under the participation restriction that lowest wages meet reservation wages. Reservation wages are endogenously determined in the institutional market economy. We give conditions guaranteeing a finite optimal firm size. Using CES-production technologies we illustrate how firm size depends on labor substitutability, and show that a linear technology yields the deepest structure and a complementary the flattest structure.
Optimal firm size governance hierarchy internal organization structure cooperative game permission value labor substitutability general equilibrium