Organizational Economics

May 13 and 14, 2011

Luis Garicano, London School of Economics; Claire LeLarge, SESSI; and John Van Reenen, London School of Economics and NBER
Firm Size Distortions and the Productivity Distribution: Evidence from France

A major empirical challenge in economics is to identify how regulations (such as labor protection) affect economic efficiency. Almost all countries have regulations that increase costs when firms cross a discrete size threshold. Garicano, LeLarge, and Van Reenen show how these size-contingent regulations can be used to identify the equilibrium and welfare effects of regulation through combining a new model with the joint firm-level distribution of size and productivity. Their framework adapts the Lucas (1978) model to a world with size-contingent regulations and applies this to France, where there are sharp increases in firing costs (which they model as a labor tax) when firms employ 50 or more workers. Using administrative data on the universe of firms in 2002 through 2007, they show how this regulation has major effects on the distribution of firm size (a "broken power law" ) and productivity. They then econometrically recover the key parameters of the model in order to estimate the costs of regulation, which appear to be substantial.

Chang-Tai Hsieh, University of Chicago and NBER, and Peter Klenow, Stanford University and NBER

The Life-Cycle of Plants in Mexico and India

In developed economies, such as the United States, manufacturing plants either grow or die. Conditional on survival, their employment rises over the first several decades of their life. In contrast, surviving plants in India exhibit little growth: Indian plants start smaller and stay small. Most Indian manufacturing employment exists at informal plants with fewer than 50 workers. Mexico is intermediate to India and the United States in these respects. However, it is more like the United States in that the death rate is highest for young plants, whereas in India the death rate is lowest for young plants. According to Hsieh and Klenow, these plant dynamics could reflect lower investments by Indian plants in process efficiency, product quality, and product variety, as well as weaker selection on both entry and exit.

Lorenzo Caliendo, Yale University, and Esteban Rossi-Hansberg, Princeton University and NBER
The Effect of Trade on Organization and Productivity

A firm's productivity depends on how production is organized, given the level of demand for its product. To capture this mechanism, Caliendo and Rossi-Hansberg develop a theory of an economy where firms with heterogeneous demands use labor and knowledge to produce. Entrepreneurs decide the number of layers of management and the knowledge and span of control of each agent. As a result, in the theory, heterogeneity in demand leads to heterogeneity in productivity and in other firms' outcomes. The researchers use the theory to analyze the impact of international trade on organization and then calibrate the model to the U.S. economy. Their results indicate that, as a result of a bilateral trade liberalization, firms that export will increase the number of layers of management and will decentralize decisions. The new organization of the average exporter results in higher productivity, although the responses of productivity are heterogeneous across these firms. In contrast, non-exporters reduce their number of layers, decentralization, and, on average, their productivity. The marginal exporter increases its productivity by about 1 percent and its revenue productivity by about 1.8 percent.

Yeon-Koo Che, Wouter Dessein, and Navin Kartik, Columbia University
Pandering to Persuade

A principal chooses one of multiple projects or an outside option. An agent is privately informed about the projects' benefits and shares the principal's preferences except for not internalizing her value from the outside option. Che, Dessein, and Kartik show that strategic communication is characterized by pandering: the agent biases his recommendation toward better-looking projects, even when both parties would be better off with some other project. The authors identify when projects are better-looking and find that it need not coincide with higher expected values. They develop comparative statics and study how organizations can try to ameliorate the pandering distortion.

Heikki Rantakari, University of Southern California
Employee Initiative and Managerial Control

Rantakari analyzes the interaction between a manager and an employee in a setting where both parties can come up with new ideas for implementation. For low levels of managerial effort, Ihere is a competition effect, whereby increased effort by the manager increases employee effort. To utilize this competition effect and to maximize employee initiative, the manager should always retain formal authority over which ideas to implement but at the same time should limit her involvement in the idea generation stage. Too much involvement will crowd out employee initiative, while too little involvement or control will allow the employee to pursue his pet projects at the detriment of overall organizational goals. Alternatively, if the cost of employee initiative is too large in terms of the compromised quality of managerial ideas, then the manager will prefer to work alone. The worst possible outcome arises when the manager is involved enough to demotivate the employee but is not good enough to generate strong alternatives herself. Additional results illustrate how the manager can rely on competition between employees as a source of ideas and how the optimal level of managerial involvement interacts with the use of performance-based pay.

Florian Ederer, University of California at Los Angeles, and Johannes Spinnewijn, London School of Economics
Information Search and Revelation in Groups

Ederer and Spinnewijn analyze costly information acquisition and information revelation in groups evaluating different decision options in a dynamic setting. Even when group members have perfectly aligned interests the group may inefficiently delay decisions. When deadlines are absent or far, uninformed group members free-ride on each others' efforts to acquire information. When deadlines come close, successful group members stop revealing their information in an attempt to incentivize others to continue searching for information. Surprisingly, setting a tighter deadline may increase the expected decision time and increase the expected accuracy of the decision in the unique equilibrium. As long as the deadline is set optimally, welfare is higher when information is only privately observable to the agent who obtained information rather than to the entire group.

Maria Guadalupe, Columbia University and NBER, and Catherine Thomas and Olga Kuzmina, Columbia University
Innovation and Foreign Ownership

Guadalupe, Kuzmina,and Thomas use a rich panel dataset of Spanish manufacturing firms (1990-2006) and a propensity score re-weighting estimator to show that multinational firms acquire the most productive domestic firms which, on acquisition, conduct more product and process innovation (simultaneously adopting new machines and organizational practices). These firms also adopt foreign technologies, leading to higher productivity. The authors propose a model of endogenous selection and innovation in heterogeneous firms that jointly explains the observed selection process and the innovation decisions. Further, they show in the data that innovation on acquisition is associated with the increased market scale provided by the parent firm.

Ian Larkin, Harvard University
Paying $30,000 for a Gold Star: An Empirical Investigation into the Value of Peer Recognition to Software Salespeople

Larkin estimates the value placed by salespeople at a leading enterprise software vendor on winning a major award: induction into the vendor's annual "Sales Club," which is awarded to the top 10 percent of salespeople each year. The "Sales Club" carries no monetary prize, and largely only confers peer recognition on winners, such as a company-wide email from the CEO identifying winners and the placement of a "gold star" on winners' business cards. The authors rely on the non-linear nature of the vendor's sale incentive scheme, and the fact that all salespeople are told how close they are to the 10 percent threshold at the end of the third quarter each year, to identify salespeople who face a discrete choice: close deals in the fourth quarter to increase the likelihood they will make the "Sales Club," or delay deals until the first quarter of the following year and earn greater commissions. Using standard revealed preference techniques around these choices, the researchers estimate that the average salesperson places a value of $27,000 on admittance to the "Sales Club." They also show that admittance to the "Sales Club" carries no identifiable benefits in terms of future sales, commissions or job mobility, suggesting that this $27,000 valuation is composed entirely of non-monetary factors. Since male salespeople and those with higher tenure value the award significantly more than female salespeople or those newer to the organization, they suggest that a desire for competition, and not a drive for status or legitimacy in the organization, underlies these results.

Jin Li and Niko Matouschek, Northwestern University
The Burden of Past Promises

Li and Matouschek propose a scenario in which a manager and an employee are in an infinitely repeated relationship. Effort and profits are observable but not contractible. The opportunity costs of bonus payments are privately observed by the managers. The optimal relational contract trades off the benefits of adapting bonus payments to their opportunity costs with the costs of conflict that arise when bonus payments are contingent on those opportunity costs. Consecutive periods with high opportunity costs lead to a gradual reduction in effort and eventually induce the manager to promise a guaranteed bonus that will be paid even if opportunity costs are high. Such conflicts end with a single period with low opportunity costs during which the manager pays a large bonus and the employee agrees to return a pre-conflict effort level. The optimal relational contract therefore gives rise to asymmetric and infinitely repeated cycles during which profits and effort decline gradually and recover instantaneously. If the firm is liquidity constrained, then recoveries become sluggish, and the employee may increase effort during a conflict.

Mrinal Ghosh, University of Arizona; Francine Lafontaine, University of Michigan; and Desmond Lo, Santa Clara University
Delegation and Pay-for-Performance: Evidence from Industrial Sales Force

Theory suggests that pay-for-performance incentives need to be aligned with appropriate levels of delegation, but empirical research on the extent of delegation, and on the relationship between delegation and pay-for-performance, remains scarce. Ghosh, Lafontaine, and Lo offer some evidence in the context of industrial sales forces: consistent with theory, they find that sales people are given more pricing authority when they have superior local information, but less pricing authority when the need for coordination within the firm is greater. The data here also show that managers give more pricing authority to sales people who are more experienced. Most importantly, the authors find that sales persons' pay-for-performance is positively and robustly related to the level of delegation of pricing authority.

Nicholas Bloom, Stanford University and NBER; Benn Eifert, Overland Advisors LLC; Aprajit Mahajan and John Roberts, Stanford University; and David McKenzie, The World Bank
Does Management Matter. Evidence from India

A long-standing question in social science is to what extent differences in management cause differences in firm performance. To investigate this, Bloom, Eifert, Mahajan, McKenzie, and Roberts ran a management field experiment on large Indian textile firms. provided free consulting on modern management practices to a randomly chosen set of treatment plants and then comparing their performance to the control plants. The researchers find that adopting these management practices had three main effects. First, it raised average productivity by 11 percent through improved quality and efficiency and reduced inventory. Second, it increased decentralization of decision making, as better information flow enabled owners to delegate more decisions to middle managers. Third, it increased the use of computers, necessitated by the data collection and analysis involved in modern management. Since these practices were profitable, this raises the question of why firms had not adopted these before. The results suggest that informational barriers were a primary factor in explaining this lack of adoption. Modern management is a technology that diffuses slowly between firms, with many Indian firms initially unaware of its existence or impact. Since competition was limited by constraints on firm entry and growth, badly managed firms were not rapidly driven from the market.

Timothy F. Bresnahan, Stanford University and NBER; Rebecca Henderson, Harvard University and NBER; and Shane Greenstein, Northwestern University and NBER
Schumpeterian competition and diseconomies of scope: illustrations from the histories of Microsoft and IBM

Bresnahan, Henderson, and Greenstein address a longstanding question about the causes of creative destruction. Dominant incumbent firms, long successful in an existing technology, are often much less successful in new technological eras. This is puzzling, because a cursory analysis would suggest that incumbent firms have the potential to take advantage of economies-of-scope across new and old lines of business and, if economies of scope are unavailable, to simply reproduce entrant behavior by creating a "firm within a firm." There are two broad streams of explanation for incumbent failure in these circumstances. One posits that incumbents fear cannibalization in the market place and so under-invest in the new technology. The second suggests that incumbent firms develop organizational capabilities and cognitive frames that make them slow to "see" new opportunities and that make it difficult to respond effectively once the new opportunity is identified. Here the authors draw on two of the most important historical episodes in the history of the computing industry, the introduction of the PC and of the browser, to develop a third hypothesis. Both IBM and Microsoft, having been extremely successful in an old technology, came to have grave difficulties competing in the new, despite some dramatic early success. The results here suggest that these difficulties do not arise from cannibalization concerns nor from inherited cognitive frames. Instead they reflect diseconomies of scope rooted in assets that are necessarily shared across both businesses. Both Microsoft and IBM were initially very successful in creating free standing business units that could compete with entrants on their own terms, but as the new businesses grew, the need to share key firm-level assets imposed significant costs on both businesses and created severe organizational conflict. In IBM and Microsoft's case, this conflict eventually led to control over the new business being given to the old and in both cases that effectively crippled the new business.

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