Organizational Economics

October 31 - November 1, 2014
Robert Gibbons, MIT, Organizer

Benjamin Hermalin, University of California, Berkeley

At the Helm, Kirk or Spock? The Pros and Cons of Charismatic Leadership

Charisma is seen as a generally positive attribute for a leader to possess, yet many studies give it a "mixed report card": finding it can have little or no effect, or worse a negative effect. Hermalin develops a model to explain why. The key insight is that presenting the cold hard truth is often incompatible with simultaneously firing up followers - a tradeoff exists between information and inspiration. In particular, a temptation exists to hide bad news behind upbeat rhetoric. Rational followers understand such appeals conceal bad news. But as long as any followers are swayed by such appeals - respond to the leader's charisma - rational followers' pessimism is tempered, and more so the more charismatic the leader. Hence, a more charismatic leader can generate better responses from all followers with an emotional appeal than can a less charismatic leader. This is a benefit to charisma. But this power has a dark side: a highly charismatic leader is tempted to substitute charm for action - she is less likely to learn relevant information and, on certain margins, works less hard herself - all to her followers' detriment.

Rocco Macchiavello, Warwick University, and Ameet Morjaria, Harvard University

Competition and Relational Contracts: Evidence from Rwanda's Coffee Mills

Macchiavello and Morjaria study the effects of competition (in procurement of raw materials) on relational contracts (RC) using Rwanda coffee mills as a case study. The researchers measure several dimensions of RC between mills and farmers and find i) dispersion across mills in the use of RC, ii) RC practices are correlated with each other, iii) RC are correlated with capacity utilization and unit processing costs. They develop a model highlighting the relationship between competition, RC, mill and farmer outcomes. They estimate an engineering model for the optimal placement of mills to instrument for competition to test the predictions of the model. Competition reduces RC, lowers utilization and increases mills' processing costs. As a result of RC breakdown, the authors can reject a positive effect of competition on farmers, including increases in prices. The evidence rationalizes policies, such as zoning regulations, monopsony licensing and other entry restrictions, commonly observed in the developing world and emphasizes the importance of promoting contractual enforcement in agricultural value chains.

Philippe Aghion and Raffaella Sadun, Harvard University and NBER; Nicholas Bloom, Stanford University and NBER; and John Van Reenen, London School of Economics and NBER

Never Waste a Good Crisis? Growth and Decentralization in the Great Recession

Aghion, Bloom, Sadun, and Van Reenen argue that decentralization is particularly beneficial to firm performance in "bad times." The researchers present a model where bad times increase the importance of rapid action, and improve the alignment of incentives of managers within firms. They test this idea exploiting the 2008-2009 Great Recession using firm-level, cross-country panel data combined with their survey data on firm organization. Firms who decentralized more decisions to local managers prior to the (industry-country specific) recession shock had better sales growth and TFP growth than their more centralized peers. Firms that scored one standard deviation above the mean on the authors' decentralization measure shrank half as slowly in industries hit by a crisis. This relationship is particularly strong in environments where uncertainty increased most severely and where pre-existing agency problems were greatest.

Steven Blader and Claudine Gartenberg, New York University, and Andrea Prat, Columbia Business School

The Contingent Effect of Management Practices

Blader, Gartenberg, and Prat investigate how the success of a management practice depends on the nature of the relational contract between the firm and its employees. A large U.S. logistics company is in the process of fitting its trucks with an electronic on-board recorder (EOBR), which provide drivers with information on their driving performance. In this setting, a natural question is whether the optimal managerial practice consists of: (1) Letting each driver know his or her individual performance only; or (2) Also providing drivers with information about their ranking with respect to other drivers. The company is also in the first phase of a multi-year "lean-management journey." This phase focuses exclusively on changing employee values, mainly toward a greater emphasis on teamwork and empowerment. The main result of the researchers' randomized experiment is that (2) leads to better performance than (1) in a particular site if and only if the site has not yet received the values intervention and worse performance if it has. The result is consistent with the presence of a conflict between competition-based managerial practices and a cooperation-based relational contract; it also highlights the role of relational contracts in determining the success of management practice.

Timo Ehrig and Jürgen Jost, Max Planck Institute for Mathematics in the Sciences, and Massimo Warglien, Ca Foscari University

A Formal Framework for Strategic Representations and Conceptual Reorganization

In this paper, Ehrig, Jost, and Warglien introduce a formal language for modeling the structure of strategic representations and operations that conceptualize change on basis of them. Strategic representations are lower dimensional representations of the world that underlie the understanding of what business environments are, how they may change, and attempts to shape them. The researchers start from discussing known strategic representations like Porter's five forces model or the strategy canvas. The authors elicit the conceptual structure underlying these representations by capturing them in their formal language. They demonstrate that their formal language can express operations of conceptual change of strategies such as stretching (the extension of value ranges), lifting (deleting dimensions), extending (adding dimensions), amalgamation (enabling new combinations of features by amalgamating different domains), and transferring structure (exploring analogies). These operations can be the basis for strategizing: for seeing possible reorganizations of strategies and even to become aware of new opportunities. They apply these operations to explain classical business cases, including a detailed study of the conceptual structure underling Steve Jobs' digital hub concept. The researchers' formal language is, to their knowledge, the first attempt to capture the variety of conceptual operations underlying strategic change using one comprehensive model.

Mark Granovetter, Stanford University

The Impact of Mental Constructs on Economic Action: Norms, Values, Moral Economy, Culture, Schemata and Institutional Logics

Guido Friebel, Miriam Krüger, and Nick Zubanov, Goethe University Frankfurt, and Matthias Heinz, University of Cologne

Team Incentives and Performance: Evidence from a Retail Chain

While there is ample evidence that incentive pay increases the performance of workers when individual performance is measurable, comparable evidence for teams is scarce. Friebel, Heinz, Krüger, and Zubanov fill this gap by a randomized experiment on team incentives in a retail chain of roughly 200 shops and 1200 employees. It is technologically impossible to measure individual performance, but the firm measures team, that is, shop performance along various dimensions. Using stratified randomization, the authors introduced a team bonus conditioned on sales targets that were fixed well before the team incentive was discussed. Treated shops increase their sales on average by 3%, and wages increase by around 2.3% on average (and up to 10%). The team incentive works best for (i) shops in larger towns and cities where the marginal productivity of effort is highest; (ii) shops with younger employees, for whom the marginal costs of effort is likely to be lowest; and (iii) shops that did not reach their targets regularly before the introduction of the bonus, for whom the effect of effort on the marginal probability of success is likely to be largest.

Daniel Barron and Michael Powell, Northwestern University

Policy Commitments in Relational Contracts

How should an organization choose policies to strengthen its relationships with employees and partners? Barron and Powell explore how biased policies arise in relational contracts using a flexible dynamic game between a principal and several agents with unrestricted vertical transfers and symmetric information. If relationships are publicly observed, then optimal policies are never biased - they are always chosen to maximize total continuation surplus. In contrast, if relationships are bilateral - each agent observes only his own output and pay - then the principal may systematically choose backward-looking, history-dependent policies to credibly reward an agent who performed well in the past. The researchers first show that biased policies are prevalent in a broad class of settings. Then they argue that biases can manifest in interesting ways in several simple examples. For instance, hiring may lag demand, promotions may be awarded in biased tournaments, and allocation decisions may "stick with" an inefficient worker.

Marian Moszoro, University of California, Berkeley, and Kozminski University; Pablo Spiller, University of California, Berkeley and NBER, and Sebastian Stolorz, George Mason University

Rigidity of Public Contracts

Moszoro, Spiller, and Stolorz apply algorithmic data reading and textual analysis to compare the features of contracts in regulated industries subject to public scrutiny (which the authors call "public contracts") with relational private contracts. The researchers show that public contracts are lengthier and have more rule-based rigid clauses; in addition, their renegotiation is formalized in amendments. They also find that contract length and the frequency of rigidity clauses increases in political contestability and closer to upcoming elections. They maintain that the higher rigidity of public contracts is a political risk adaptation strategy carried out by public agents attempting to lower third-party opportunistic challenges.

Laurent Frésard, University of Maryland; Gerard Hoberg, University of Southern California; and Gordon Phillips, University of Southern California and NBER

The Incentives for Vertical Acquisitions and Integration

Fresard, Hoberg, and Phillips examine the incentives for firms to vertically integrate through acquisitions and production. The researchers develop a new firm-specific measure of vertical integration using 10-K product text to identify the extent to which a firm's products span vertically-related product markets. They find that firms in high R&D industries are less likely to vertically integrate or become targets in vertical acquisitions. These findings are consistent with firms with unrealized innovation avoiding integration to maintain ex ante incentives to invest in intangible assets and maintain residual rights of control as in Grossman and Hart (1986). In contrast, firms in high patenting industries with mature product markets are more likely to be vertically integrated consistent with control rights being obtained by firms to facilitate commercialization of already realized innovation.

Wouter Dessein, Columbia University, and Tano Santos, Columbia University and NBER

Managerial Style and Attention

A large empirical literature has shown how firm behavior is correlated with the background and expertise of its managers. But managerial knowledge and expertise are largely endogenous. Dessein and Santos develop a cognitive theory of manager fixed effects, where the allocation of managerial attention determines firm behavior. A manager learns about two strategic choices, each pertaining to a different task (e.g. operations and marketing). The manager then communicates about the chosen strategies to an organization, which must implement them in a decentralized way. The need for coordinated implementation makes it optimal to communicate "narrow" strategies, focused on one task. This, in turn, may induce the manager to "manage with style": despite the risk of being blindsided and forsaking valuable opportunities, the manager focuses all her attention to learn about one task and mainly communicates to the organization about this task. The researchers show that in uncertain, complex environments, the endogenous allocation of attention exacerbates manager fixed effects. Small differences in managerial expertise then may result in dramatically different firm behavior, as managers devote scarce attention in a way which amplifies initial differences. Firm owners (e.g. boards) then prefer managers with task-specific expertise rather than generalist managers, even when they themselves have no preference for a particular strategy. In contrast, in less complex and more certain environments, the endogenous allocation of attention mitigates manager fixed effects and boards optimally hire generalists with equal expertise in both tasks.

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