Organizational Economics

December 6-7, 2013
Robert Gibbons of MIT, Organizer

Roland Bénabou, Princeton University and NBER, and Jean Tirole, Institut d'Economie Industrielle

Bonus Culture: Competitive Pay, Screening, and Multitasking (NBER Working Paper 18936)

Benabou and Tirole analyze the impact of labor market competition and skill-biased technical change on the structure of compensation. The model combines multitasking and screening embedded into a Hotelling-like framework. Competition for the most talented workers leads to an escalating reliance on performance pay and other high-powered incentives, thereby shifting effort away from less easily contractible tasks such as long-term investments, risk management, and within-firm cooperation. Under perfect competition, the resulting efficiency loss can be much larger than that imposed by a single firm or principal who distorts incentives downward in order to extract rents. More generally, as declining market frictions lead employers to compete more aggressively, the monopsonistic under-incentivization of low-skill agents first decreases, then gives way to a growing over-incentivization of high-skill ones. Aggregate welfare is thus hill-shaped with respect to the competitiveness of the labor market, while inequality tends to rise monotonically. Bonus caps and income taxes can help restore balance in agents' incentives and behavior, but may generate their own set of distortions.

Kieron Meagher and Rodney Strachan, Australian National University

Evidence on the Non-Linear Impact of Management

Management practices have been shown to have a significant and economically large impact on firm output after controlling for a range of standard factors such as other inputs, industry, etc. Meagher and Strachan investigate non-linearities in the impact of management practices on firm performance using a Gaussian process and a continuous piece-wise linear approach with probabilistically smoothed endogenous breaks. In all cases the authors find significant evidence of a U-shaped relationship, with the biggest returns to management occurring when management practices are at their highest levels.

Alessandro Bonatti, MIT, and Heikki Rantakari, USC Marshall School of Business

The Politics of Compromise

A team must select among competing projects that differ in their payoff consequences for its members. Each agent chooses a project and exerts costly effort affecting its random completion time. When one or more projects are complete, agents bargain over which one to implement. Bonatti and Rantakari find that requiring unanimity can, but need not, induce the efficient balance between compromise in project selection and equilibrium effort. Imposing deadlines for presenting counterproposals or delaying their implementation achieves the constrained-efficiency benchmark. Delegating decision making to an impartial third party leads agents to select extreme projects. Hiring agents with opposed interests can foster both effort and compromise in project selection.

Stephen Burks, University of Minnesota Morris; Bo Cowgill, University of California, Berkeley; Mitchell Hoffman, University of Toronto; and Michael Housman, University of Pennsilvania

The Facts About Referrals: Toward an Understanding of Employee Referral Networks

Using unique personnel data from nine large firms in three industries, Burks, Cowgill, Hoffman, and Housman document several consistent facts about hiring through employee referrals on five topics: (1) applicant quality and hiring, (2) worker quality, (3) wages and turnover, (4) productivity and profits, and (5) ties between referring and referred workers. First, referred applicants have similar skill characteristics to non-referred applicants, both observable-to-the-firm (for example, schooling) and unobservable-to-the-firm (such as cognitive and non-cognitive ability), but are more likely to be hired, more likely to accept job offers, and have higher pre-job assessment scores. Second, referred workers have similar skill characteristics to non-referred workers. Third, referred workers are less likely to quit, have slightly higher wages, and have similar wage variance. Fourth, referred workers have similar productivity on standard non-rare performance metrics, but superior performance on rare high-impact metrics. Fifth, workers who make referrals have higher productivity than others, are less likely to quit after making a referral, and refer those like themselves on particular productivity metrics. Differences between referred and non-referred workers tend to be larger at low-tenure levels: for young, black, and Hispanic workers, and in strong labor markets. No leading class of theories alone can account for all or most of these facts, leading the authors to suggest several theoretical extensions.

Marina Halac and Andrea Prat, Columbia University

Managerial Attention and Worker Engagement

Halac and Prat study a dynamic agency problem with two-sided moral hazard: the worker chooses whether to exert effort or shirk, and the manager chooses whether to invest in paying attention to the worker's performance. In equilibrium the worker uses past recognition to infer managerial attention. An engagement trap arises: absent recent recognition both worker effort and managerial investment decrease, making a return to high productivity less likely as time passes. In a sample of ex ante identical firms, firm performance, managerial quality, and worker engagement display heterogeneity across firms, positive correlation, and persistence over time.

Ilya Segal, Stanford University, and Michael Whinston, MIT and NBER

Property Rights and the Efficiency of Bargaining

Rui de Figueiredo,University of California, Berkeley; Evan Rawley, Columbia University; and Orie Shelef, Stanford University

Bad Bets: Excessive Risk-Taking, Convex Incentives, and Performance

Managerial incentives influence risk taking as well as effort. Theoretical research has long considered inefficient risk taking to be a potential side effect of incentive pay, but empirical analysis that examines effort and risk taking simultaneously has been limited. de Figueiredo, Rawley, and Shelef use exogenous variation in incentives to separate how convex incentive schemes influence performance and risk taking. The authors first establish that when hedge fund managers fall below their threshold, beyond which they earn performance fees, risk taking increases and performance drops. On average, risk taking increases 50 percent and performance falls 2.3 percentage points when a hedge fund is below the incentive threshold. The authors then examine the link between performance and risk taking explicitly. First, they separately identify the shirking and risk-taking effects of being below the incentive threshold and show that excessive risk taking, rather than shirking, causes much of the performance declines. Second, they show that risk-taking behavior is non-monotonic; managers who are significantly below the threshold reduce risk taking relative to those who are moderately below. These results suggest that risk taking, because of convex incentives, is not only inefficient - inappropriately choosing from the efficient risk-return frontier given the principal's objectives - but excessive in taking risks that are dominated and lead to absolute performance declines. The importance of risk taking to performance adds to the debate about the impact of incentives on behavior. Whether increasing incentive intensity is justified by moral hazard considerations, or concerns about adverse selection, it is crucial to recognize how incentive-induced risk taking will influence organizational performance.

Björn Bartling, University of Zurich, and Manuel Grieder and Christian Zehnder, University of Lausanne

Delegating Responsibility to the Market: How Competition Shapes Fairness Perceptions

While competition is a central pillar of economics, little is known yet about its psychological implications. In this study Bartling, Grieder, and Zehnder show that competition shapes fairness perceptions. If a trading party delegates the determination of the terms of trade to a competitive mechanism, unfavorable terms trigger significantly less counterproductive behavior from the interaction partner than if the trading party implements the same terms directly. This effect is robust to an increase in the intensity of competition, a stronger involvement of the deciding trading party in the competitive process, and a change in the access characteristics of competition. The authors' results suggest that competition alters the attribution of blame.

Arthur Campbell, Yale University

Political Capital

Decision making inside organizations often requires aggregating dispersed information through communication. Campbell considers a mechanism in which an expert sacrifices future participation in decision making to influence the current period's decision in favor of his preferred project. This mechanism captures a notion often described as "political capital" whereby an individual is able to achieve his own preferred decision in the current period at the expense of being able to exert influence in future decisions ("spending political capital" ). The author shows that this mechanism facilitates communication in environments where information is verifiable neither ex ante nor ex post. He shows that first-best decision making is possible when agents value future participation sufficiently. When the first best is not possible, the decision rule increases the influence of the expert relative to the first best. In a multi-expert setting a finite team size is found to be optimal.

Laura Alfaro, Harvard Business School; Paola Conconi, ECARES, Université Libre de Bruxelles; Harald Fadinger,University of Vienna; and Andrew Newman, Boston Universty

Do Prices Determine Vertical Integration? Evidence from Trade Policy (NBER Working Paper 16118)

What is the relationship between product prices and vertical integration? While the literature has focused on how integration affects prices, Alfaro, Conconi, Fadinger, and Newman show that prices can affect integration. Many theories in organizational economics and industrial organization posit that integration, while costly, increases productivity. If true, it follows from firms' maximizing behavior that higher prices induce firms to be more integrated. The reason is that at low prices increases in revenue resulting from enhanced productivity are too small to justify the cost, whereas at higher prices the revenue benefit exceeds the cost. Trade policy provides a source of exogenous price variation to assess the validity of this prediction: higher tariffs should lead to higher prices and therefore to more integration. The authors construct firm-level indices of vertical integration for a large set of countries and industries and exploit cross-section and time-series variation in import tariffs to examine their impact on firm boundaries. Their empirical results provide strong support for the view that output prices are a key determinant of vertical integration.

Sandeep Baliga, Northwestern University, and Tomas Sjöström, Rutgers University

Coordination, Rent-Seeking and Control

Two agents want to coordinate their decisions but may also try to extract rents from each other. Decisions are negotiated at the interim stage, when the agents have private information. The agent who owns an asset has the right to make a unilateral decision regarding this asset, so negotiations must satisfy a participation constraint. Baliga and Sjostrom compare non-integration, where each agent owns one asset, with integration, where one agent owns both assets. They derive simple necessary and sufficient conditions for the first best to be implemented with integration or non-integration. These conditions can never be satisfied simultaneously, so integration sometimes dominates non-integration and vice versa.

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