Organizational Economics

Organizational Economics Working Group met April 12-13 in Cambridge. Research Associate Robert S. Gibbons of MIT organized the meeting. These researchers' papers were presented and discussed:

Andrea Prat, Columbia University; Michael C. Best, Columbia University and NBER; and Adnan Khan and Oriana Bandiera, London School of Economics

Incentives and the Allocation of Authority in Organizations: A Field Experiment with Bureaucrats

Organizations use combinations of explicit performance incentives and rules prescribing behavior to motivate workers. However, monitoring of adherence to rules creates a second set of agents subject to their own agency problems. Prat, Bandiera, Best, and Khan provide a formal model of the effectiveness of performance incentives and worker autonomy in improving organizational performance. The model highlights the importance of the relative alignment of frontline workers and their monitors with organizational goals. The researchers implemented a large-scale randomized control trial with the government of Punjab, Pakistan to provide the first experimental evidence on the effects of incentives and autonomy in a bureaucracy. The researchers find that increasing procurement officers' autonomy vis-à-vis their auditors improves prices paid throughout the fiscal year without reducing quality. Performance pay incentives reduce prices early in the year, but increase them at the end of the year when auditors have greater hold-up power, making the average effect of incentives zero. The results suggest auditors are less concerned with saving public money than procurement officers are. The results have important implications for the design of monitoring and anti-corruption policies.

Devesh Rustagi, Goethe University Frankfurt

Waiting for Napoleon? Historical Democracy and Norms of Cooperation

Rustagi uses a natural experiment to study the effect of historical experience of democracy on norms of cooperation today. In the Middle Ages, the extinction of the Zaehringen dynasty from the absence of an heir resulted in some Swiss municipalities acquiring historical forms of democracy, but the others continued largely under feudalism until Napoleon intervened. Behavioral and survey measures show that individuals from treated municipalities display stronger norms of cooperation than individuals from control group municipalities. These differences persist due to cultural transmission, as well as economic prosperity, education, and better functioning of democratic institutions in treated municipalities.

Mitchell Hoffman, University of Toronto and NBER; Guido Friebel and Nick Zubanov, Goethe University Frankfurt; and Matthias Heinz, University of Cologne

What Do Employee Referral Programs Do?

Employee referral programs (ERPs) are randomly introduced in a grocery chain. Larger bonuses increase referrals and decrease referral quality, though the increase in referrals is modest. Still, ERPs are highly profitable, partly, because referred workers stay longer, but, mainly, because in treated stores, non-referrals stay longer. In a rollout, referral rates remain low for grocery jobs, but are high for non-grocery jobs, which are perceived as more attractive. Hoffman, Friebel, Heinz, and Zubanov's results (1) are consistent with referral-making being driven by money and altruism toward friends, and (2) show that ERPs can have substantial benefits beyond generating referrals by making workers feel more respected.

Guo Xu, University of California, Berkeley; Marianne Bertrand, University of Chicago and NBER; and Robin Burgess, London School of Economics

Social Proximity and Bureaucrat Performance: Evidence from India (NBER Working Paper No. 25389)

Using exogenous variation in social proximity generated by an allocation rule, Xu, Bertrand, and Burgess find that bureaucrats assigned to their home states are perceived to be more corrupt and less able to withstand illegitimate political pressure. Despite this, the researchers observe that home officers are more likely to be promoted in the later stages of their careers. To understand this dissonance between performance and promotion the researchers show that incoming Chief Ministers preferentially promote home officers that come from the same home district. Taken together, the results suggest that social proximity hampers bureaucrat performance by facilitating political capture and corruption.

Daniel V. Barron and Yingni Guo, Northwestern University

The Use and Misuse of Coordinated Punishments

Communication facilitates cooperation by ensuring that deviators are collectively punished. Barron and Guo explore how players might misuse equilibrium messages to threaten one another, and the researchers identify conditions under which communication improves cooperation despite such threats. In the model, a principal plays trust games with a sequence of short-run agents who communicate with each other. A shirking agent can demand pay by threatening to report that the principal deviated. The researchers show how these threats can destroy cooperation. However, some cooperation is restored if players observe public signals of efforts or transfers, or if the principal has a bilateral relationship with each agent.

Oliver D. Hart, Harvard University and NBER, and David Frydlinger, Cirio Law Firm

Overcoming Contractual Incompleteness: The Role of Guiding Principles

Hart and Frydlinger develop a model where a buyer and seller contract over a service. The contract encourages the seller to invest and provides a reference point for the transaction. In normal times the contract works well. But with some probability an abnormal state occurs and the service must be modified. This puts the parties below their reference payoffs and may cause costly disagreement. The researchers discuss why neither classical mechanisms nor lawyers' standard approaches adequately deal with this issue. The adoption by the parties of guiding principles such as loyalty and equity as part of their contract can help.

Daniela Scur, MIT, and Renata Lemos, The World Bank

The Ties That Bind: Family CEOs, Management Practices and Firing Costs

Family firms are the most prevalent firm type in the world, particularly in emerging economies. Although dynastic family firms tend to have lower productivity, what explains their underperformance is still an open question. Scur and Lemos collect new data on CEO successions for over 900 firms in Latin America and Europe to document their corporate governance choices and provide the first causal evidence on the negative effect of dynastic CEO successions on the adoption of managerial structures tied to improved productivity. Specifically, the researchers establish two key results and propose a novel mechanism. First, there is a preference for male heirs: when the founding CEO steps down they are 30 percentage points more likely to keep control within the family when they have a son. Second, instrumenting with the gender of the founder's children, the researchers estimate dynastic CEO successions lead to almost one standard deviations lower adoption of "best practices" managerial structures, suggesting an implied productivity decrease of up to 10%. To guide the discussion on mechanisms, the researchers build a stylized model with two types of CEOs (family and professional) who decide whether to invest in better management practices. Family CEOs cannot credibly commit to disciplining employees without incurring reputation damage. This induces lower worker effort and reduces the returns to investing in management structures. The researchers find empirical evidence that, controlling for lower knowledge and skill levels of managers, reputational costs constrain investment in productivity-enhancing management structures.

Christian Zehnder, University of Lausanne; Ernst Fehr, University of Zurich; and Oliver D. Hart, Harvard University and NBER

Contracts, Conflicts and Communication

Previous research emphasizes that free-form communication fosters cooperation, facilitates coordination and reduces conflicts. Zehnder, Fehr, and Hart show that communication does not always improve economic exchange. They explore a contracting environment in which competition tends to create considerable payoff inequality in favor of the buyer. Inequality poses a threat to efficiency, because sellers who end up with little surplus tend to engage in counterproductive behavior. In the absence of communication buyers can reduce conflicts with sellers by proposing rigid contracts with ex ante fixed prices. The downside is that contractual rigidity prevents efficient trade in some states of the world. The researchers' experiment tests whether the availability of free-form communication allows for a superior solution in which flexibility prevails and buyers use communication to forestall conflicts. The data reveal that this is not the case. The communication technology is predominantly used for influence activities through which sellers try to obtain a larger share of the surplus. These influence activities further increase the potential for conflicts, because sellers who fail to influence buyers respond even more harshly to low prices. As a consequence, buyers minimize conflicts and maximize profits if they choose rigid contracts and refuse to communicate. Further experimental treatments show that the findings are robust to the presence of information asymmetries.

Christopher Cornwell and Ian M. Schmutte, University of Georgia, and Daniela Scur, MIT

Picking From the Top or Shedding the Bottom? Personnel Management, Worker Quality and Firm Productivity

It is well established that organizational practices matter for workforce composition and productivity, but the mechanisms behind these effects are less well understood. Cornwell, Schmutte, and Scur explore how structured personnel management practices relate to actual HR outcomes and productivity. They match structured management practices data from the World Management Survey to AKM estimates of worker and firm fixed effects and industrial survey data from ten years of Brazilian administrative data. The researchers- have four key findings: first, consistent with the literature, worker and manager fixed effects, as well as structured management, are positively correlated with firm productivity. Second, the researchers find evidence of positive recruitment: better managed firms hire a larger share of their new recruits -- managers and production workers -- from the top of the distribution of worker fixed effects. Third, they find suggestive evidence of better worker matching and retention from lower separation rates. Fourth, the researchers decompose the variation of personnel management practices and find that promotion and retention practices show the strongest correlation with manager fixed effects.

Monica Martinez-Bravo, Centro de Estudios Monetarios y Financieros (CEMFI); Gerard Padró I Miquel, Yale University and NBER; Nancy Qian, Northwestern University and NBER; and Yang Yao, Peking University, China

The Rise and Fall of Local Elections in China: Theory and Empirical Evidence on the Autocrat's Trade-off (NBER Working Paper No. 24066)

Martinez-Bravo, Padró I Miquel, Qian, and Yao propose a simple informational theory to explain why autocratic regimes introduce local elections. Because citizens have better information on local officials than the distant central government, delegation of authority via local elections improves selection and performance of local officials. However, local officials under elections have no incentive to implement unpopular centrally mandated policies. The model makes several predictions: i) elections pose a trade-off between performance and vertical control, ii) elections improve the selection of officials, and iii) an increase in bureaucratic capacity reduces the desirability of elections for the autocrat. To test (i) and (ii), the researchers collect a large village-level panel dataset from rural China. Consistent with the model, they find that elections improve (weaken) the implementation of popular (unpopular) policies, and improve official selection. The researchers provide a large body of qualitative and descriptive evidence to support (iii). In doing so, they shed light on why the Chinese government has systematically undermined village governments twenty years after they were introduced.

Melanie Meng Xue, Northwestern University, and Mark Koyama, George Mason University

Autocratic Rule and Social Capital: Evidence from Imperial China

Xue and Koyama explore the impact of autocratic rule on social capital -- defined as the attitudes, beliefs, norms, and perceptions that support cooperation. Political repression is a distinguishing characteristic of autocratic regimes. Between 1661-1788, individuals in imperial China were persecuted if they were suspected of holding subversive attitudes towards the state. A difference-in-differences approach suggests that in an average prefecture, exposure to political repression led to a decline of 38% in local charities -- a key proxy of social capital. In line with the historical panel results, individuals have lower levels of generalized trust today in affected prefectures. Taking advantage of institutional variation in 20th century China, and using two instrumental variables, the researchers provide further evidence that political repression permanently reduced social capital. Moreover, individuals in prefectures with a legacy of literary inquisitions are more politically apathetic. More suggestively, there appears to be a self-reinforcing cycle in which autocratic rule becomes entrenched through causing a permanent decline in social capital.

Heikki Rantakari, University of Rochester

Simon Says? (Interpersonal) Authority in Organizations

Rantakari contrasts the efficiency of two coordination mechanisms, decentralized coordination and authority, in resolving coordination problems in organizations. Under decentralized coordination, the agents (subordinates) responsible for different tasks are also responsible for acquiring and sharing information about their tasks and then executing a plan of action. In contrast, under authority, a principal (superior) processes all relevant information and then instructs the subordinates as to what actions to take, and the subordinates choose to follow these instructions without further evaluation. The analysis thus revisits the classic notion of authority as the ability of an individual to instruct others on what to do and to expect obedience, and formalizes it as an endogenous equilibrium information structure of a game. Both types of equilibria can co-exist, with the advantage of authority lying in the strategic management of information made available to the subordinates, which facilitates coordinated adaptation to opportunities without exposing the organization to excessive opportunism. Authority dominates decentralized coordination whenever the parties exhibit moderate patience and cost disadvantage of authority in processing information is not too large.

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