Nicholas Bloom: Decentralized Firms are More Recession-Proof

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Nicholas Bloom: Decentralized Firms are More Recession-Proof

Research shows that flexibility wins in bad economic times.
Worker at a metal warehouse
When times are tough, it’s good to push power down to the people on the ground. | Reuters/Stringer

The worldwide “Great Recession,” which got into full swing in 2008 after Lehman’s collapse, sparked heated debate over which organizational structures are best in helping companies weather severe economic crises. Should several local managers have the ability to make important decisions, or should just a few top executives make the aggressive and challenging choices, over layoffs and cost-cutting, that often accompany bad economic times?

The answer, according to Nicholas Bloom, who teaches at Stanford Graduate School of Business, is the one that provides more autonomy to its managers. “Decentralization helps firms perform better, particularly in bad times,” says Bloom, coauthor of “Never Waste a Good Crisis? Growth and Decentralization in the Great Recession,” a working paper.

Bloom’s paper, coauthored with Philippe Aghion of Harvard University, Raffaella Sadun of Harvard Business School, and John Van Reenen of the Centre for Economic Performance at London School of Economics, examined company performance just before and during the Great Recession and found that firms that decentralized their decision making had lower falls in their sales and faster increases in their productivity than those with a centralized structure.

Uncertainty rises and conditions change quickly during a recession, increasing the need for companies to respond to such dynamic times, the researchers say. That’s more likely to occur when managers are empowered to make decisions instead of waiting for orders to filter down from the executive suite. “It’s really costly to have big response times, so that would suggest pushing decisions down,” Bloom says.

These findings, Bloom says, sharply contrast with the longstanding notion that centralized firms perform more strongly during recessions because they allow C-suite executives to make the tough and unpleasant decisions about plant closures, layoffs, and other types of aggressive cost-cutting, assumed to be the primary survival strategy in a downturn. Although the researchers examined midsized manufacturing companies, the findings apply to various industries, says Bloom.

The researchers conducted a series of phone interviews in 2006 with North American, European, and Japanese plant managers at manufacturing firms with a median size of 150 workers. The interviewers, who were business students, asked the managers how much they could spend on capital investments without approval from headquarters. They also discussed with the managers the decision-making process in hiring, launching new products, and sales and marketing. Interviewers rated answers on a numerical scale to reflect the level of authority the plant manager had.

The researchers ranked the companies based on their decentralization scores and also examined their sales and productivity before and after the crisis (using data from 2006 to 2011). All the firms saw a drop in sales during the recession, but on average, for those that were more centralized the decline was 10%, sharper than the 6.2% decline for decentralized ones.

Decentralization during hard times helps sales, especially in companies where the CEO isn’t physically present, the researchers also found. In that kind of remote setup, the CEO and plant manager are generally less trusting of each other, at times pulling the company in different directions and hurting performance.

But when a recession arrives, the interests of the plant manager and top management quickly align. “Their feet are up against the fire, and everyone starts pulling in the same direction” with the common goal of staying afloat, says Bloom. Once the plant manager agrees with the CEO on common goals, he or she can have a drastic impact on company performance if the firm is decentralized, giving the manager the autonomy to act. That impact is more pronounced than in firms where the CEO is onsite and is on the same page as the plant manager from the start.

Their feet are up against the fire, and everyone starts pulling in the same direction with the common goal of staying afloat.
Nicholas Bloom, professor of economics (by courtesy)

The researchers found a similar phenomenon at companies where the plant manager has a relatively short tenure. A newer manager is probably less loyal than one with a lengthy tenure and thus might act in ways that don’t fully benefit the firm — working shorter hours, for instance. But when the pressure to survive in a recession hits, that new manager quickly changes behavior, aligns with the CEO, and, if the company is decentralized, will likely make decisions that help the firm to a large degree. Again, the impact will be larger than in firms where the plant manager is a veteran who has long been loyal and been acting in ways that help the company all along.

The key takeaway? “When conditions get tough,” Bloom says, “it’s a good time to push power down to the people on the ground who really know what’s going down.”

Nicholas Bloom is a professor in the Department of Economics at Stanford University and by courtesy at Stanford Graduate School of Business.

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