Internal Competition for Corporate Resources and Incentives in Teams

Invoking the free-rider problem in teams, many observers find profit sharing in large organizations puzzling, because it should have negligible incentive effects. We show that if a firm can be decomposed into two separate teams whose outputs can be observed, then profit sharing combined with competition between these two teams for internal resources frequently solves the free-rider problem. Using this result, we endogenize the firm's organizational structure and show that in the presence of economies of scale, small firms tend to organize as unitary firms, while large firms choose the multidivisional organizational form.