Catherine Thomas (LSE)

In-house and arm's length: Productivity heterogeneity and variation in organisational form

This paper studies variation in firm boundaries in the US hotel industry. For most hotel brands, the properties with the lowest and highest occupancy rates are managed at arm's length by franchisees. Properties with intermediate levels of room occupancy tend to be managed by company employees, meaning that hotel management is vertically integrated. For high-end brands, in contrast, the likelihood a property is vertically integrated is always increasing in occupancy rate. These findings are consistent with a model of organizational form choice where output depends on relationship-specific and non-contractible inputs from both the brand and the manager and on relationship productivity. Organizational form affects the input levels of the brand and the manager through two types of incentive mechanisms: incentives related to residual control rights as well as explicit performance-related incentives for the manager. Relationship productivity determines the relative effect of each incentive mechanism on output and brand profits and, hence, the preferred organizational form for a specific hotel property.