Overconfidence by Bayesian Rational Agents

This paper derives two mechanisms through which Bayesian-rational individuals with differing priors will tend to be relatively overconfident about their estimates and predictions, in the sense of overestimating the precision of these estimates. The intuition behind one mechanism is slightly ironic: in trying to update optimally, Bayesian agents overweight information of which they over-estimate the precision and underweight in the opposite case. This causes overall an over-estimation of the precision of the final estimate, which tends to increase as agents get more data.

Authority versus Persuasion

This paper studies a principal's trade-off between using persuasion versus using interpersonal authority to get the agent to 'do the right thing' from the principal's perspective (when the principal and agent openly disagree on the right course of action). It shows that persuasion and authority are complements at low levels of effectiveness but substitutes at high levels. Furthermore, the principal will rely more on persuasion when agent motivation is more important for the execution of the project, when the agent has strong intrinsic or extrinsic incentives, and, for a wide range of settings, when the principal is more confident about the right course of action.

Culture Clash: The Costs and Benefits of Homogeneity

This paper develops an economic theory of the costs and benefits of corporate culture -- in the sense of shared beliefs and values -- in order to study the effects of 'culture clash' in mergers and acquisitions. I first use a simple analytical framework to show that shared beliefs lead to more delegation, less monitoring, higher utility (or satisfaction), higher execution effort (or motivation), faster coordination, less influence activities, and more communication, but also to less experimentation and less information collection. When two firms that are each internally homogenous but different from each other, merge, the above results translate to specific predictions how the change in homogeneity will affect firm behavior. The paper's predictions can also serve more in general as a test for the theory of culture as homogeneity of beliefs.

The Limits of Authority: Motivation versus Coordination

This paper studies the effects of open disagreement on motivation and coordination. It shows how - in the presence of differing priors - motivation and coordination impose conflicting demands on the allocation of authority, leading to a trade-off between the two. The paper first derives a new mechanism for delegation: since the agent thinks - by revealed preference applied to differing priors - that his own decisions are better than those of the principal, delegation will motivate him to exert more effort when effort and correct decisions are complements. A need for implementation effort will thus lead to more decentralization. The opposite holds for substitutes. Delegation, however, reduces coordination when people disagree on the right course of action. The paper shows that - with differing priors - the firm needs to rely more on authority (as opposed to incentives) to solve coordination problems, relative to the case with private benefits. An interesting side-result here is that the principal will actively enforce her decisions only at intermediate levels of the need for coordination. The combination of the two main results implies a trade-off between motivation and coordination, both on a firm level and across firms. I derive the motivation-coordination possibility frontier and show the equilibrium distribution of effort versus coordination. I finally argue that strong culture, in the sense of homogeneity, is one (costly) way to relax the trade-off

On the Origin of Shared Beliefs (and Corporate Culture)

This paper shows why members of an organization often share similar beliefs. I argue that there are two mechanisms. First, when performance depends on making correct decisions, people prefer to work with others who share their beliefs and assumptions, since such others 'will do the right thing'. Second, beliefs will converge over time through shared learning. While such homogeneity reduces agency problems, it does so at a cost. I show that, from an outsider's perspective, firms invest on average too much in homogeneity. The theory further predicts that homogeneity will be strongest in successful and older firms where employees make important decisions. Within a firm, homogeneity will be stronger among more important employees. Homogeneity will also be path-dependent, making managers more selective on early hires. Since shared beliefs are an important aspect of corporate culture (Schein 1985, Kotter and Heskett 1992), I finally show that the model matches some observations on corporate culture, such as the influence of a manager on her firm's culture and the persistence of culture in the face of turnover. A fundamental difference from earlier economic theories of corporate culture is that I show that culture, instead of being created for its own good, can be a side-effect of other purposeful actions. As a consequence, there can be too much culture in firms

Too Motivated?

I show that an agent's motivation to do well (objectively) may be unambiguously bad in a world with differing priors, i.e., when people openly disagree on the optimal course of action. The reason is that an agent who is strongly motivated is more likely to follow his own view of what should be done. As a result, the agent is more willing to disobey his principal's orders when the two of them disagree on the right course of action. This effect has a number of implications. First of all, agents who are subject to authority will have low-powered incentive pay. Second, intrinsically motivated agents will be more likely to disobey and less likely to be subject to authority. Firms with intrinsically motivated agents will need to rely on other methods than authority for coordination. Moreover, an increase in intrinsic motivation may decrease all players' expected utility, so that it may be optimal for a firm to look for employees with low intrinsic motivation. Finally, subjective performance pay may be optimal, even when the true outcome of the project is perfectly measurable and contractible. Through this analysis, the paper identifies an important difference between differing priors and private benefits (or private information): with differing priors, pay-for-performance can create agency problems rather than solving them

Organizational Beliefs and Managerial Vision

This paper studies, in a world with differing priors, the role of organizational beliefs and managerial vision in the behavior and performance of corporations. The paper defines vision operationally as a very strong belief by the manager about the right course of action for the firm. The interaction between employees' beliefs and the manager's vision influences decisions and determines employees' motivation and satisfaction. Through sorting in the labor market, the manager's vision also shapes organizational beliefs. Under weak conditions, a company's board should select a manager with stronger beliefs than its own, although spurious effects may make vision often look better than it really is. The analysis shows that beliefs play an important role that goes beyond their information content. It also has implications for theories of corporate culture and business strate

Why Do Firms Have “Purpose”? The Firm's Role as a Carrier of Identity and Reputation

Why do so many firms publicly espouse a "purpose" beyond simple profit maximization? And why do so many managers and employees appear to care deeply about this purpose and to believe that it is critically important? In this paper we argue that the conventional answers to this question fail to account for the fact that employees usually care whether the pursuit of purpose is authentic and that the embrace of purpose often affects even employees whose own work is remote from the activities that put the purpose into action. In this paper we propose instead that firms may adopt a socially driven purpose because of how it affects—through the visibility of firm membership and through the visibility of the firm's actions—employee identity and reputation, where we define "identity" as our own beliefs about ourselves and "reputation" as others' beliefs about ourselves

Contract Adaptation under Legal Constraints

Abstract This paper shows theoretically that automobile distribution contracts can be seen as efficient responses to the manufacturers' obligation to offer non-discriminatory terms to dealers. This legal rule may prevent the parties from adapting contracts to new contingencies even when performance is ex post verifiable, as manufacturers may be unable to reach advantageous bargains with heterogeneous dealers using one-size-fits-all instruments. To circumvent the law and improve adaptation, manufacturers amend contracts informally, efficiently tailoring them to dealers' characteristics. Moreover, to make future informal amendments self-enforcing, contracts assign authority to manufacturers ex ante when the dealers are strongly averse to change, so manufacturers may be tempted to renege, ex post, on the large bonuses necessary to make them accept the amendments voluntarily. The model can be extended to employment, franchising and, more generally, to all contracts linking a central party to a set of parties with inferior bargaining power, where anti-discrimination rules may apply

Ernst Freund as Precursor of the Rational Study of Corporate Law

Gindis, David, Ernst Freund as Precursor of the Rational Study of Corporate Law (October 27, 2017). Journal of Institutional Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2905547, doi: https://dx.doi.org/10.2139/ssrn.2905547The rise of large business corporations in the late 19th century compelled many American observers to admit that the nature of the corporation had yet to be understood. Published in this context, Ernst Freund's little-known The Legal Nature of Corporations (1897) was an original attempt to come to terms with a new legal and economic reality. But it can also be described, to paraphrase Oliver Wendell Holmes, as the earliest example of the rational study of corporate law. The paper shows that Freund had the intuitions of an institutional economist, and engaged in what today would be called comparative institutional analysis. Remarkably, his argument that the corporate form secures property against insider defection and against outsiders anticipated recent work on entity shielding and capital lock-in, and can be read as an early contribution to what today would be called the theory of the firm.Peer reviewe