Organizational Economics

April 24 and 25, 2015
Robert Gibbons of MIT, Organizer

David Chan, Jr, Stanford University and NBER

Tacit Learning and Influence behind Practice Variation: Evidence from Physicians in Training

Studying physicians in training, Chan investigates how uncertainty and tacit knowledge may give rise to "weak best practices," which allow for significant practice variation in organizations. Consistent with tacit learning, and empirically exploiting a discontinuity in the formation of teams, the researcher finds that relative experience substantially increases the influence of a physician on variation. Learning sufficient to generate convergence occurs for patients on services driven by specialists, a difference unexplained by formal diagnostic codes. In contrast, rich physician characteristics correlated with preferences and ability, and quasi-random assignments to high- or low-spending supervising physicians explain little if any variation.

Oliver D. Hart, Harvard University and NBER, and Maija Halonen-Akatwijuka, Bristol University

Short-term, Long-term, and Continuing Contracts (NBER Working Paper No. 21005)

Parties often regulate their relationships through "continuing" contracts that are neither long-term nor short-term but usually roll over. Halonen-Akatwijuka and Hart study the trade-off between long-term, short-term, and continuing contracts in a two-period model where gains from trade exist in the first period, and may or may not exist in the second period. A long-term contract that mandates trade in both periods is disadvantageous since renegotiation is required if there are no gains from trade in the second period. A short-term contract is disadvantageous since a new contract must be negotiated if gains from trade exist in the second period. A continuing contract can be better. In a continuing contract there is no obligation to trade in the second period but if there are gains from trade the parties will bargain "in good faith" using the first period contract as a reference point. This can reduce the cost of negotiating the next contract. Continuing contracts are not a panacea, however, since good faith bargaining may preclude the use of outside options in the bargaining process and as a result parties will sometimes fail to trade when this is efficient.

Anne Preston, Haverford College, and Casey Ichniowski, Columbia University

Do Star Performers Produce More Stars? Peer Effects and Learning in Elite Teams (NBER Working Paper No. 20478)

In this study, Ichniowski and Preston investigate the professional soccer industry to ask whether the talent of an individual's co-workers helps explain differences in the rate of human capital accumulation on the job. Data tracking national soccer team performance and the professional leagues their members play for is particularly well suited for developing convincing non-experimental evidence about these kinds of peer effects. The empirical results consistently show that performance improves more after an individual has been a member of an elite team than when he has been member of lower level teams. The conclusion is borne out by a rich set of complementary data on: national team performance, player-level performance, performance of foreign players who joined elite teams after an exogenous shift in the number of foreign players participating on top club teams, performance of players on national teams in the year just before and the year just after they join an elite club team, and experiences of several national team players obtained through personal interviews.

Robert Akerlof, University of Warwick, and Richard Holden, University of New South Wales

Movers and Shakers

Most projects, in most walks of life, require the participation of multiple parties. While it is difficult to unite people in a common endeavor, some people, whom the authors call "movers and shakers," seem able to do it. This paper specifically examines moving and shaking of an investment project. Akerlof and Holden analyze a model with a large number of ex ante identical agents. Agents form social connections bid to buy ownership and cashflow rights to an asset that is necessary for undertaking a project, and acquire private iid signals of the project's quality, which they can communicate, at a cost, to those with whom they are linked. Finally, agents choose whether to invest in the project whose returns are a function both of its underlying quality and aggregate investment. The researchers characterize the equilibrium of this game, including the endogenously formed network structure, information flows, and payoffs. They show that a single agent emerges as most connected; these connections confer the ability to increase aggregate investment (i.e., move and shake the project); he consequently earns a rent. In extensions, the authors move away from the assumption of ex ante identical agents to highlight various forces that lead one agent or another to become a mover and shaker. Finally, the researchers explore various applications, including: anchor investors, funds management, and insider trading.

Alexander Peysakhovich, Harvard University, and David Rand, Yale University

Habits of Virtue: Creating Norms of Cooperation and Defection in the Laboratory

What explains variability in norms of cooperation across organizations and cultures? One answer comes from the internalization of norms prescribing behavior that is typically successful under the institutions that govern one's daily life. These norms are then carried over into atypical situations beyond the reach of institutions. Here Peysakhovich and Rand experimentally demonstrate such spillovers. First, they immerse subjects in environments that do or do not support cooperation using repeated Prisoner's Dilemmas. Afterwards, the researchers measure their intrinsic prosociality in one-shot games. Subjects from environments that support cooperation are more prosocial, more likely to punish selfishness, and more generally trusting. Furthermore, these effects are most pronounced among subjects who use heuristics, suggesting that intuitive processes play a key role in the spillovers they observe. The authors' findings help to explain variation in one-shot anonymous cooperation, linking this intrinsically motivated prosociality to the externally imposed institutional rules experienced in other settings.

David Rand, Yale University, and Joshua D. Greene and Martin A. Nowak, Harvard University

Spontaneous Giving and Calculated Greed

David Rand, Gordon T. Kraft-Todd and George E. Newman, Yale University, and Alexander Peysakhovich, Owen Wurzbacher, Martin A. Nowak and Joshua D. Greene, Harvard University

Social Heuristics Shape Intuitive Cooperation

Rebecca Henderson, Harvard University and NBER, and Hazhir Rahmandad and Nelson P. Repenning, MIT

Making the Numbers? 'Short Termism' & the Puzzle of Only Occasional Disaster (NBER Working Paper No. 17095)

Much recent work in strategy and popular discussion suggests that an excessive focus on "managing the numbers" — delivering quarterly earnings at the expense of longer term performance — makes it difficult for firms to make the investments necessary to build competitive advantage. "Short termism" has been blamed for everything from the decline of the U.S. automobile industry to the low penetration of techniques such as TQM and continuous improvement. Yet a vigorous tradition in the accounting literature establishes that firms routinely sacrifice long-term investment to manage earnings and are rewarded for doing so. This paper presents a model that reconciles these apparently contradictory perspectives. Rahmandad, Repenning, and Henderson show that if the source of long-term advantage is modeled as a stock of capability that accumulates over time, the intensity of the firm's effort to manage short-term earnings at the expense of long-term investment can have very different consequences depending on whether the firm's capability is close to a critical "tipping threshold." When the firm operates above this threshold, aggressively managing earnings smoothes revenue and cash flow with few long-term consequences. Below it, managing earnings can tip the firm into a vicious cycle of accelerating decline. These results have important implications for understanding managerial incentives and the internal processes that create sustained advantage.

Steven Grenadier, Stanford University; Andrey Malenko, MIT; and Nadya Malenko, Boston College

Timing Decisions in Organizations: Communication and Authority in a Dynamic Environment

This paper develops a theory of how organizations make timing decisions. Grenadier, Malenko, and Malenko consider a problem where an uninformed principal decides when to exercise an option and interact with an informed but biased agent. This problem is common: examples include headquarters deciding when to close a plant, drill an oil well, or launch a product. Because time is irreversible, the direction of the agent's bias is crucial for communication and allocation of authority. When the agent favors late exercise, centralized decision-making, where the principal retains authority and communicates with the agent, often features full information revelation but inefficient delay. Delegation is never optimal in this case. In contrast, when the agent favors early exercise, communication under centralized decision-making is partial, while option exercise is unbiased or delayed. Delegation is optimal if the bias is small or delegation can be timed. Thus, delegating decisions such as plant closures is never optimal, while delegating decisions such as product launches may be optimal.

Birger Wernerfelt, MIT

The Size of Markets and the Scope of Firms

In this paper, Wernerfelt contrasts transactions in markets with those in firms and characterizes the optimal numbers in each. Governance structures appear as equilibria and are compared in terms of production costs — determined by a tradeoff between specialization and adaptation — and bargaining costs. Under natural conditions, employment or local markets weakly dominate all other equilibria. As local markets become smaller, the parties are better adapted to each other, but bargaining costs make it inefficient to be very small. As firms become larger, gains from specialization come at the cost of increasingly poor adaptation, ultimately bounding their scope.

Danielle Li, Harvard University; Mitchell Hoffman, University of Toronto; and Lisa Kahn, Yale University and NBER

Discretion in Hiring

Who should make hiring decisions? Many firms rely on hiring managers to evaluate applications and make job offers. These hiring managers may be informed about a worker's quality, but their efficacy may be undermined by biases or bad judgement. The use of quantitative metrics such as job testing enables firms to limit these concerns, but potentially at the cost of ignoring valuable information. This paper examines whether firms should rely on hard metrics or grant managers discretion in making hiring decisions. Hoffman, Kahn, and Li evaluate the staggered introduction of a job test across 131 locations of 15 firms employing low-skill service sector workers. The researchers show that testing improves the match quality of hired workers, as measured by their completed tenure, by about 15%. Further, when faced with similar applicant pools, the authors find that managers who exercise more discretion (as measured by their likelihood of overruling the test recommendations) systematically end up with worse hires. This result suggests that managers make exceptions to test recommendations because they are biased, not because they are better informed. In this setting, the researchers find that firms can improve productivity by limiting managerial discretion.

Luis Garicano, London School of Economics, and Luis Rayo, University of Utah

Why Organizations Fail: Models and Cases

Organizations fail due to incentive problems (agents do not want to act in the organization's interests) and bounded rationality problems (agents do not have the necessary information to do so). This survey uses recent advances in organizational economics to illuminate organizational failures along these two dimensions. Garicano and Rayo combine reviews of the literature with simple models and case discussions. Specifically, the researchers consider failures related to the allocation of authority and short-termism, both of which are instances of "multitasking problems"; communication failures in the presence of both soft and hard information due to incentive misalignments; resistance to change due to vested interests and rigid cultures; and failures related to the allocation of talent and miscommunication due to bounded rationality. The authors find that the organizational economics literature provides parsimonious explanations for a large range of economically significant failures.

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