Organizational Economics

Members of the NBER's Organizational Economics Working Group met in Cambridge on November 16-17. Research Associate Robert S. Gibbons of MIT organized the meeting. These researchers' papers were presented and discussed:

Anna Gumpert, LMU Munich; Henrike Steimer, Stanford University; and Manfred Antoni, Institue of Employment Research

Firm Organization with Multiple Establishments

How do geographic frictions affect firm organization? Gumpert, Steimer, and Antoni show theoretically and empirically that geographic frictions increase the use of middle managers in multi-establishment firms. In the model, they assume that the time of the CEO of a firm is a resource of limited supply that is shared among the headquarters and the establishments. Geographic frictions increase the costs of accessing the CEO. Hiring middle managers at an establishment substitutes for CEO time that is reallocated over all establishments. In consequence, geographic frictions between the headquarters and one establishment affect the organization of all establishments of a firm. The model is consistent with novel facts about multi-establishment firm organization that the researchers document using administrative data from Germany. They exploit the opening of high speed train routes to show that not only the establishments directly affected by faster travel times but also the other establishments of the firm adjust their organization. The findings imply that local conditions propagate across space through firm organization.

Samuel Hafner, University of Basel, and Curtis Taylor, Duke University

Contracting for Research: Moral Hazard and the Incentive to Overstate Significance

Hafner and Taylor explore how a principal contracts with an agent, who is protected by limited liability, to acquire information concerning the desirability of investing in a project. To motivate the agent to perform the required research, it is necessary to offer him a schedule of contingent rewards that depend on his reported unverifiable findings and on the project's ultimate outcome. While the contingent rewards can be calibrated to solve the moral hazard problem ex ante, they endogenously create an adverse selection problem ex post. In particular, they generate an incentive for the agent to exaggerate the significance of his research findings, leading to another source of agency rents. The principal mitigates these rents by committing to ignore reports of extremely positive or extremely negative findings, i.e. extreme reports of either kind are bunched. Thus, the principal commits to under-utilize some of the agent's potential information.

Raphael Boleslavsky and Kyungmin Kim, University of Miami

Bayesian Persuasion and Moral Hazard

Boleslavsky and Kim consider a three-player Bayesian persuasion game in which the sender designs a signal about an unknown state of the world, the agent exerts a private effort that determines the distribution of the underlying state, and the receiver takes an action after observing the signal and its realization. The sender must not only persuade the receiver to select a desirable action, but also incentivize the agent's effort. The researchers develop a general method of characterizing an optimal signal in this environment. The method is applied to derive concrete results in several natural examples and discuss the economic implications.

Jin Li, London School of Economics; Michael L. Powell, Northwestern University; and Rongzhu Ke, Hong Kong Baptist University

Firm Growth and Promotion Opportunities

Li, Powell, and Ke develop a model in which a firm makes a sequence of production decisions and has to motivate each of its employees to exert effort. The firm motivates its employees through incentive pay and promotion opportunities, which may differ across different cohorts of workers. The researchers show that the firm benefits from reallocating promotion opportunities across cohorts, resulting in an optimal personnel policy that is seniority-based. The main contribution is to highlight a novel time-inconsistent motive for firm growth: when the firm adopts an optimal personnel policy, it may pursue future growth precisely to create promotion opportunities for existing employees.

Mitra Akhtari, Harvard University; Diana B. Moreira, University of California, Davis; and Laura C. Trucco, Harvard University

Political Turnover, Bureaucratic Turnover and the Quality of Public Services

Akhtari, Moreira, and Trucco study how political turnover in mayoral elections in Brazil affects public education provision. Exploiting a regression discontinuity design for close elections, they find that municipalities with a new party in office subsequently have test scores that are .05-.08 standard deviations lower. Party turnover leads to a sharp increase in the replacement rate of headmasters and teachers in schools controlled by the municipality. In contrast, turnover of the mayor's party does not impact local (non-municipal) schools. These findings suggest that political turnover can adversely affect the quality of public services when the bureaucracy is not shielded from the political process.

Anton Kolotilin, University of New South Wales, and Andriy Zapechelnyuk, University of St. Andrews

Persuasion Meets Delegation

There are two common ways for a principal to influence the decision making of an agent. One is to manipulate the agent's information (persuasion problem). Another is to limit the agent's decisions (delegation problem). Kolotilin and Zapechelnyuk show that, under general assumptions, these two problems are equivalent, so solving one problem solves the other. The researchers illustrate how the methods developed in the persuasion literature can be applied to address unsolved delegation problems by considering monopoly regulation with a participation constraint.

Abhijit Banerjee and Esther Duflo, MIT and NBER; Arun G. Chandrasekhar, Stanford University and NBER; and Matthew Jackson, Stanford University

Changes in Social Network Structure in Response to Exposure to Formal Credit Markets

Banerjee, Chandrasekhar, Duflo, and Jackson study how the introduction of microfinance changes the networks of interactions among 16,476 households in 75 Indian villages, and develop a new dynamic model of network formation to explain the empirical findings. None of the villages were exposed to microfinance by 2006, and 43 villages were through 2010. Using a two-wave panel of network data collected in 2006 and 2012, the researchers compare changes in networks in villages exposed to microfinance relative to those not exposed. Networks exposed to microfinance experience a significantly greater loss of links -- for credit relationships as well as advice and other types of relationships -- compared to those not exposed. Microfinance not only results in decreases in relationships among those likely to get loans, but also decreases in relationships between those unlikely to get loans. These patterns are inconsistent with models of network formation in which people have opportunities to connect with whomever they wish, but are consistent with a model that emphasizes chance meetings that depend on relative efforts to socialize coupled with conditional choices of whom to connect with, as well as externalities in payoffs across relationships between pairs and triples of people.

Yanhui Wu, University of Southern California, and Feng Zhu, Harvard University

Competition, Contracts, and Worker Efforts in Creative Production

Wu and Zhu study the effects of competition on worker effort and performance under different incentive structures on a Chinese novel-writing platform. Authors produce and sell their works chapter-by-chapter under a revenue-sharing or pay-by-the-word contract with the platform. Exploiting a regulation that induced a massive entry of romance novels, but not others, the researchers find that, on average, intensified competition led authors to produce content faster while the effect on book novelty was weak. However, revenue-sharing books responded to competition substantially more than pay-by-the-word books, particularly regarding novelty. Finally, the platform increased promotion of contracted books, and this increase disproportionately favored pay-by-the-word books.

Charles Angelucci, Columbia University; Simone Meraglia, University of Exeter; and Nico Voigtländer, University of California, Los Angeles and NBER

How Merchant Towns Shaped Parliaments: From the Norman Conquest of England to the Great Reform Act (NBER Working Paper No. 23606)

Angelucci, Meraglia, and Voigtländer study the process that led to the inclusion of merchant towns in the English Parliament, using a novel comprehensive dataset for 549 medieval English towns (boroughs). The analysis begins with the Norman Conquest in 1066 -- an event of enormous political change that resulted in largely homogenous formal institutions across England. From this starting point, the researchers document a two-step process: First, monitoring issues and asymmetric information led to inefficiencies in the king's tax collection, especially with the onset of the Commercial Revolution in the 12th century. This gave rise to mutually beneficial agreements (Farm Grants), whereby medieval merchant towns obtained the right of self-administered tax collection and law enforcement. Second, the researchers show that Farm Grants were stepping stones towards representation in the English Parliament after its creation in 1295: to raise extra-ordinary taxes (e.g., for wars) from self-governed towns, the king had to negotiate with them -- and the efficient institution to do so was Parliament. The researchers show that royal boroughs with trade-favoring geography were much more likely to be represented in Parliament, and that this relationship worked through Farm Grants. The researchers also show that medieval self-governance had important long-term consequences and interacted with nationwide institutional changes. Boroughs with medieval Farm Grants had persistently more inclusive local elections of public officials and MPs, they raised troops to back the parliamentarians during the Civil War in 1642, and they supported the Great Reform Act of 1832, which resulted in the extension of the franchise.

Jason Sandvik and Nathan Seegert, University of Utah; Richard Saouma, Michigan State University; and Christopher T. Stanton, Harvard University and NBER

The Power (of) Lunch and the Role of Incentives for Fostering Productive Interactions

Sandvik, Saouma, Seegert, and Stanton carried out a field experiment in a sales organization to investigate the effects of employee interactions on productivity. Encouraging agents to talk about their sales process with a partner over lunch substantially lifted sales, with average increases of 20% that persisted after the study. These gains are larger than for the agents that were provided a weekly $50 prize per partner to improve joint sales, with the prizes doing little for agents receiving the combination of treatments. The gains are largest for agents paired for lunch with above-median partners. Survey responses indicate that agents who were encouraged to interact shared best practices whereas other groups did not.

Daron Acemoglu, MIT and NBER, and Alexander Wolitzky, MIT

A Theory of Equality before the Law (NBER Working Paper No. 24681)

Acemoglu and Wolitzky propose a model of the emergence of equality before the law. A society can support "effort" ("cooperation", "pro-social behavior") using the "carrot" of future cooperation or the "stick" of coercive punishment. Community enforcement relies only on the carrot and involves low coercion, low inequality, and low effort. A society in which the elite control the means of violence supplements the carrot with the stick, and involves high coercion, high inequality, and high effort. In this regime, elites are privileged: they are not subject to the same coercive punishments as non-elites. The researchers show that it may be optimal -- even from the viewpoint of the elite -- to establish equality before the law, where all agents are subject to the same coercive punishments. The central mechanism is that equality before the law increases elites' effort, which in turn encourages even higher effort from non-elites. Equality before the law combines high coercion and low inequality -- in the baseline model, elites exert the same level of effort as non-elites. Factors that make the emergence of equality before the law more likely include limits on the extent of coercion, greater marginal returns to effort, increases in the size of the elite group, greater political power for non-elites, and under some additional conditions, lower economic inequality.

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