Organizational Economics

Members of the NBER's Organizational Economics Working Group met November 8-9 in Cambridge. Research Associate Robert S. Gibbons of MIT organized the meeting. These researchers' papers were presented and discussed:

Dana Foarta and Takuo Sugaya, Stanford University

Wait-and-See or Step-in? Dynamics of Interventions

Foarta and Sugaya study the optimal intervention policy to stop projects in a relational contract between a principal and a policymaker. The policymaker is privately informed about his ability and privately chooses how much effort to exert. Before a project is completed, the principal receives a signal about its outcome and can intervene to stop it. Intervention may prevent a bad outcome, but no intervention leads to better learning about the policymaker's ability. In the benchmarks with observable effort or observable ability, optimal intervention follows a threshold rule. With unobservable effort and ability, the optimal policy switches between intervention and no intervention.

Canice Prendergast, University of Chicago

Making A DIfference

Many organizations rely on donations of money, time, and effort to function. Prendergast considers how such organizations motivate donors concerned with "making a difference". Its tension is between a donor's desire to be marginally important against the firm's desire to make important objectives less precarious. Prendergast shows the factors that lead firms to undertake unimportant objectives before carrying out more important ones. Prendergast shows how the need to render donors more marginally important lead organizations (i) to exhibit such a lack of focus that they invest their available resources on a range of their worst projects, even when technological considerations suggested focusing on their single best project, (ii) to benefit from being unable to identify projects quality, (iii) to consciously fail to diagnose the needs of their clients, (iv) to suffer from becoming larger, and (iv) to benefit from implementing initiatives that are only of value to a narrow group of people.

Mark J. Borgschulte, University of Illinois at Urbana-Champaign; Marius Guenzel, University of California, Berkeley; Canyao Liu, Yale University; and Ulrike Malmendier, University of California, Berkeley and NBER

CEO Stress and Life Expectancy: The Role of Corporate Governance and Financial Distress

Optimal pay-for-performance has to account for private benefits distorting managerial incentives. Borgschulte, Guenzel, Liu, and Malmendier focus on one aspect of private benefits -- CEO health and mortality. Their identification exploits the staggered introduction of anti-takeover laws since the mid-1980s as well as exposure to industry shocks. Using a hand-collected data set on the dates of birth and death for more than 1,600 CEOs employed by large, publicly listed U.S. firms, the researchers estimate that CEOs insulated from market discipline via anti-takeover laws enjoy an extra year or more of life as a result. Non-linear specifications suggest mortality rates initially fall by as much as 9 percent with each year of exposure, though the incremental effects diminish rather quickly as exposure increases. The conclusions are unchanged by models that account for differences in tenure associated with exposure to the laws. The researchers also find that CEOs who exclusively served under strict governance are more likely to pass away while in office or within the first five years of stepping down as CEO. They estimate similar effects on longevity arising from exposure to industry-wide distress during a CEO's tenure. Finally, the researchers utilize machine-learning based age estimation software to detect visible signs of aging in pictures of CEOs who experience distress shocks. Using a difference-in-differences design, they estimate that apparent age increases by roughly 1 year among CEOs exposed to distress shocks during the Great Recession.

Francesco Decarolis and Paolo Pinotti, Bocconi University; Raymond Fisman, Boston University and NBER; and Silvia Vannutelli, Boston University

Rules, Discretion, and Corruption in Procurement: Evidence from Italian Government Contracting

The benefits of bureaucratic discretion depend on whether it is used to improve public welfare or exploited for private gain. Decarolis, Fisman, Pinotti, and Vannutell study the relationship between discretion and corruption in Italian government procurement auctions, using a confidential database of firms and procurement officials investigated for corruption by Italian enforcement authorities. They show that discretionary procedure auctions (those awarded on the basis of negotiated rather than open bidding) are associated with corruption only when conducted with fewer than the formally required number of bidders; the researchers similarly find that discretionary criteria ("scoring rule" rather than first price) auctions are won more often by firms investigated for corruption. Decarolis, Fisman, Pinotti, and Vannutell show that these "corruptible" discretionary auctions are chosen more often by officials who are themselves investigated for corruption, but less often in investigated procurement administrations (those in which enforcement authorities are investigating at least one procurement official). These findings fit with a model in which more discretion leads to greater efficiency as well as more opportunities for theft, and a central monitor manages this tradeoff by limiting discretion in high-corruption locales. Finally, they present two additional sets of analyses which suggest that monitors also use two standard tools - turnover and subcontracting limits - to further constrain auction officials in high corruption areas.

Nicholas Bloom, Stanford University and NBER; Michael Christensen and Jan Rivkin, Harvard University; Raffaella Sadun, Harvard University and NBER; and Mu-Jeung Yang, University of Utah

How do CEOs Make Strategy?

Bloom, Christensen, Rivkin, Sadun, and Yang survey 262 CEO alumni of Harvard Business School and gather evidence on three aspects of each executive's business strategy: how formalized it is, how it is developed, and how it is implemented. The researchers report three main results. First, CEOs use a wide range of markedly different processes to make strategic decisions, some follow highly formalized, rigorous, and deliberate processes while others rely heavily on instinct and habit. Second, more structured strategy processes are associated with larger firm size and faster employment growth. Third, using a regression discontinuity centered around a change in the curriculum of the Harvard Business School's required strategy course, the researchers show that differences in strategic decision making can be traced back at least partly to differences in managerial education.

Raúl Sanchez de la Sierra, University of Chicago and NBER, and Kristof Titeca, University of Antwerp

Corruption in Hierarchies

Sanchez de la Sierra and Titeca gain access into and experiment with a traffic police agency battalion to analyze the economics of corruption in a hierarchy. Commanders offer their protection to street-level agents, which enables the agents to collect stable revenue through a bribing system institutionalized as toll fees. In exchange, the agents detain a pre-agreed number of drivers every day, which they escort to the police station for the commanders to take bribes (the quota system). This finances respectively 94% and 79% of commanders' and police agents' income, respectively 10 times and 64 times the city minimum wage. The researchers test that the organizational structure is consistent with a simple contract theory model, and present three findings. First, bribe-taking opportunities by street-level agents incentivizes them to provide public service. To establish this result, Sanchez de la Sierra and Titeca double the daily income of street-level police agents. While bribe-taking decreases, street-level agent attendance and quality of traffic ow do too. Second, commanders' monetary taxation of street-level agents dampens this relationship: they “tax” 29% of this extra income, reducing in half the effect of extra income on street-level agents' behavior. Third, the quota vertical contracts have a negative externality on society: they create traffic congestion and harassment of drivers.

Chen Cheng and Yiqing Xing, Johns Hopkins University, and Wei Huang, National University of Singapore

A Theory of Multiplexity: Sustaining Cooperation with Multiple Relationships

People are embedded in multiple social relations. These relationships are not isolated from each other. This paper provides a framework to analyze the multiplex of networks. Cheng, Huang, and Xing present a model in which each pair of agents may form more than one relationship. Each relationship is captured by an infinitely repeated prisoner's dilemma with variable stakes of cooperation. The researchers show that multiplexity, i.e. having more than one relationship on a link, boosters incentives as different relationships serve as social collateral for each other. Cheng, Huang, and Xing then endogenize the network formation and ask: when an agent has a new link to add, will she multiplex with a current neighbor, or link with a stranger? They find the following: (1) There is a strong tendency to multiplex, and "multiplexity trap" can occur. That is, agents may keep adding relationships with current neighbor(s), even if it is more compatible to cooperate with a stranger. (2) Individuals tend to multiplex when the current network (a) has a low degree dispersion (i.e., all individuals have similar numbers of friends), or (b) is positively assortative. The researchers also find that when relationships differ in their importance, agents tend to multiplex when the new relationship is less important, and link with a stranger when it's more important. Lastly, they find empirical evidence that supports their theoretical findings.

Ernst Fehr and Ivo Schurtenberger, University of Zurich

The Dynamics of Norm Formation and Norm Decay

Social norms are a ubiquitous feature of social life and appear to pervade almost every aspect of human social interaction. They are commonly known standards of behavior that are based on widely shared views of how individual group members ought to behave. However, despite their omnipresence fundamental questions related to social norms lack convincing answers: How and when do normative standards of behavior emerge? How are they maintained and when do they decay? Do social norms activate intrinsic motivations to comply with them and are these motivations sufficient to ensure compliance? Do norms exert an independent causal effect on behavior or are they simply an epiphenomenon of the web of prevailing incentives and institutions? Do norm violations undermine or change the normative standard and the extent to which it is widely shared? Do normative standards also affect their own enforcement? Do they affect the behavioral responses to norm enforcement behaviors? Progress in answering these questions has been severely retarded by a lack of directly observable “high-frequency” measures of normative behavioral standards that assume the properties of social norms. Here, the researchers develop and validate such a measure in the context of an experimental collective action problemand show how it helps to answer the above mentioned questions. Fehr and Schurtenberger show, in particular, that widely shared normative standards do trigger compliance motives and increase participation in normatively required collective action. However, the strength and nature of the compliance motives are insufficient to ensure maintenance of social norms. In fact, in the absence of explicit opportunities for sanctioning norm violators, norms eventually lose any behavioral drawing power: initial norm violations are not sanctioned and are associated with (i) further increases in norm violations, (ii) a steady decay in the normative standard and (iii) a break-down of the normative consensus. The provision of voluntary sanctioning opportunities, however, not only blocks all three above mentioned processes but also causes an increase in the normative consensus and leads to the stable maintenance of a social norm. Finally, the researchers vary the opportunity for the formation of social norms exogenously and document that – when peer sanctioning is possible – social norms exert a causal impact by increasing the overall participation in collective action while simultaneously reducing the sanctioning of those who don’t participate. In other words, social norms render the establishment and enforcement of collective action more efficient.

Giuseppe Berlingieri, ESSEC Business School and CEP; Frank Pisch, University of St. Gallen; and Claudia Steinwender, MIT and NBER

Organizing Global Supply Chains: Input-Output Linkages and Vertical Integration (NBER Working Paper 25286)

Berlingieri, Pisch, and Steinwender study how the technological importance of inputs -- measured by cost shares -- is related to the decision to "make" or "buy" that input. Using detailed French international trade data and an instrumental variable approach based on self-constructed input-output tables, the researchers show that multinationals vertically integrate high cost share inputs. A stylized incomplete contracting model with both ex-ante and ex-post inefficiencies explains why: technologically more important inputs are "made" when transaction cost economics type forces overpower property rights type forces. However, additional results show that both types forces are needed to explain the full patterns in the data.

W. Bentley MacLeod, Columbia University and NBER, and Victoria Valle Lara and Christian Zehnder, University of Lausanne

On Building a Conflict Culture in Organizations

Although conflicts are typically associated with negative emotions and waste of resources, organizations may still benefit from a corporate culture that tolerates or even encourages conflicts. The reason is that coordinated conflicts can help to enforce social norms and foster cooperation. In this paper we report results of a series of laboratory experiments designed to explore whether and under what conditions an efficiency-enhancing conflict culture can emerge. Using a principal-worker setup with subjective performance evaluation, we show that establishing a functional conflict culture is a delicate matter. If conflicts are encouraged in a careless, hands-off manner, the destructive side of conflicts is likely to dominate. To be successful a conflict culture requires a careful management of fairness norms. In our experiment we find that conflicts have positive net effects on efficiency only if an explicit code of conduct is established and conflicts are institutionalized through a grievance process.

Katherine Casey, Stanford University and NBER; Edward Miguel, University of California, Berkeley and NBER; Rachel Glennerster, DFID; and Maarten J. Voors, Wageningen University & Research

Skill versus Voice in Local Development (NBER Working Paper 25022)

Where the state is weak, traditional authorities control the local provision of land, justice, and public goods. These authorities are criticized for ruling undemocratically, and are poorly educated relative to younger cohorts. Casey, Miguel, Glennerster, and Voors experimentally evaluate two solutions to these problems in Sierra Leone: one to foster citizen participation in governance and development projects, and another to identify skilled technocrats and delegate project management to them. In a real-world infrastructure grants competition, the researchers find that a public nudge to delegate dominates both the default of chiefly control and the participatory reform. Results uncover a broader failure of autocratic institutions to fully exploit human capital.

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