Kellogg School of Management
Management & Strategy Department
Northwestern Economics Department
Kellogg School of Management
Leverone Hall, 6th Floor
2001 Sheridan Road
Evanston, IL 60208-2001
- “Managing Conflicts in Relational Contracts” joint with Niko Matouschek (December 2012) American Economic Review, Vol 103, No. 6, (Oct 2013) pp.2328-51.
A worker interacts repeatedly with a manager who is privately informed about the opportunity
costs of paying him. The worker therefore cannot distinguish non-payments that are efficiency
enhancing from those that are rent extracting. The optimal relational contract generates periodic
conflicts during which effort and expected profits decline gradually but recover instantaneously.
To manage a conflict, the manager uses a mix of informal promises and formal commitments
that evolves with the duration of the conflict. Liquidity constraints limit the managers ability
to manage conflicts but may also induce the worker to respond to a conflict by providing more
effort rather than less.
- “Relational Contracts with Private Subjective Evaluations” joint with Joyee Deb and Arijit Mukherjee (Forthcoming) , Rand Journal of Economics.
This article analyzes the optimal use of peer evaluations in the provision of incentives within a team, and its interplay with relational contracts. We consider an environment in which the firm pays a discretionary bonus based on a publicly observed team output but may further sharpen incentives by using privately reported peer evaluations. We characterize the optimal contract, and show that peer evaluations can help sustain relational contracts. Peer evaluations are used when the firm is less patient and the associated level of surplus destruction is small. Moreover, peer evaluation affects a worker's pay only when the public output is at its lowest level and the co-worker sends the worst report. Noticeably, a worker's report does not affect his own pay, as the provision of effort incentives cannot be decoupled from the incentive for truthful reporting of peer performance. To induce the workers both to put in effort and to report truthfully, the firm may find it optimal to neglect signals that are informative of the worker's effort.
We explore subjective performance reviews in long-term employment relationships. We show that firms benefit from separating the task of evaluating the worker from the task of paying him. The separation allows the reviewer to better manage the review process, and can therefore reward the worker for his good performance with not only a good review contemporaneously, but also a promise of better review in the future. Such reviews spread the reward for the workerís good performance across time and lower the firmís maximal temptation to renege on the reward. The manner in which information is managed exhibits patterns consistent with a number of well-documented behavioral biases in performance reviews.
This paper studies a relational contracting model in which the agent is protected by a
limited liability constraint. The agentís effort is his private information and affects the output
stochastically. We characterize the optimal relational contract and compare the dynamics
of the relationship with that under the optimal long-term contract. Under the optimal
relational contract, the relationship is less likely to survive, and the surviving relationship
is less efficient. In addition, relationships always converge under the optimal long-term
contract, but they can cycle under the optimal relational contract.
We explore the evolution of power within organizations. To this end, we examine an infinitely
repeated game in which a principal can empower an agent by letting him choose a project. The
principal, however, does not know what projects are available to the agent. We characterize
the optimal relational contract and explore its implications. Our results speak to how power
is earned, lost, and retained. They show that entrenched power structures are consistent with
managers who are managing power optimally. And they provide a new perspective on two
long-standing issues in organizational economics.
Reputation is a valuable asset to firms, yet the impact of corporate governance of reputationreliant
firms is underexplored. This paper investigates how a firmís reputation in the product
market responds to a change in its controlling shareholder, and derives the optimal firm ownership
and control structure. We consider a dynamic model of an experience-goods firm, in which
a controlling shareholder actively engages in management, and the controlling share block can
be traded through private negotiation. In the optimal equilibrium, the firmís reputation in the
product market is linked to its behavior in the market for corporate control to provide proper
incentive for the controlling shareholder to maintain a good firm reputation. Our analysis also
identifies an endogenous cost of corporate control, and provides a rationale for the separation
of ownership and control. We derive the optimal ownership structure and draw implications on
the dynamics of control premium.
We consider a model in which a principal must both repay a loan and motivate an agent
to work hard. Output is non-contractible, so the principal faces a commitment problem with
both her creditor and her agent. In a profit-maximizing equilibrium, the agent's productivity
is initially low and increases over time. Productivity continues increasing even after the debt
has been repaid, eventually converging to a steady state that is independent of the size of the
initial loan. We apply the model to argue that a firm that relies on external debt will typically
under-invest in the scale of its existing businesses, but might either over- or under-invest when
expanding into new lines of business.
- “Implementing Change in Organizations” joint with Niko Matouschek, Mike Powell, and Xi Weng.
- “A Theory of Player Turnover in Games” joint with Yuk-Fai Fong.
This paper develops a model of job mobility and wage dispersion with asymmetric information. Contrary to the existing models in which the superior information of current employers lead to market collapse, this model generates a unique equilibrium outcome in which a) positive turnover exists and b) identical workers can be paid differently. The model implies that, in the presence of technological change that is skill-biased and also favors general skills over firm-specific skills, the wage distribution will become more spread out (corresponding to greater inequality) and job mobility will increase.
This paper develops a model of wage distribution and wage dynamics based on assignment and Pareto learning. The model matches a large number of key facts about wage distribution and wage dynamics. The tractability of Pareto learning allows us to derive joint implications on the wage distribution and wage dynamics as assignment becomes more important. Our model also provides a natural framework for decomposing the earning variance into a permanent component and a transitory one, and it helps explain why the growing importance in assignment can lead to both higher wage inequality and higher wage instability.
Firms' organizational structures impose constraints on their ability to use promotion-based incentives. We develop a framework for identifying these constraints and exploring their consequences.
We show that firms manage workers careers by choosing personnel policies that
resemble an internal labor market. Firms may adopt forced-turnover policies to keep lines of
advancement open, and they may alter their organizational structures to relax these constraints.
This gives rise to a trade-off between incentive provision at the worker level and productive efficiency at the firm level. Our framework generates novel testable that connect firm-level characteristics with workers' careers.
We develop a model of turnover and wage dynamics with insurance, match-specific productivity, and long-term contracting. The model predicts that wages are downward rigid within firms but can decrease when workers are fired. We apply the model to study the impact of business cycles on subsequent wages and job mobility. Workers hired during a boom have persistent
higher future wages if staying with the same firm. However, these boom hires are more likely
to be terminated and have shorter employment spells.
- “Going for it: The Adoption of Risky Strategies in Tournament” joint with Jen Brown.
This paper studies bidder behavior in simultaneous, continuous, ascending price auctions. We design and implement a "collusion incubator" environment based on a type of public, symmetrically "folded" and "item-aligned" preferences. Tacit collusion develops quickly and reliably within the environment. Once tacit collusion developed, it proved remarkably robust to institutional changes that weakened it as an equilibrium of a game-theoretic model. The only succcessful remedy was a non-public change in the preference of participants that destroyed the symmetrically, "folded" and "item aligned" patterns of preferences, creating head-to-head competition between two agents reminiscent of the concept of a "maverick."
This paper investigates firms’ abilities to tacitly collude when these firms each monopolize a proprietary aftermarket. When firms’ aftermarkets are isolated from foremarket competition, they cannot tacitly collude more easily than single-product firms do. However, when their aftermarket power is contested by foremarket competition as equipment owners view new equipment as a substitute for their incumbent firm’s aftermarket product, the monopoly profit is sustainable among a larger number of firms. These results hold regardless of whether consumers are sophisticated enough
to anticipate a price war upon observing a deviation. Conditions under which introduction of aftermarket competition hinders firms’ ability to tacitly collude are characterized.
In an uncertain environment, when does an increase in the breadth of activities in which individuals interact together help foster collaboration on each activity? We show that when players,
on average, prefer to stick to a cooperative agreement rather than reneging by taking their privately optimal action, then collaboration can be approximately sustained in a sufficiently
broad relationship. This is in contrast to existing results showing that a cooperative agreement can be sustained only if players prefer to adhere to it in every state of the world. We consider
applications to favor exchange, multimarket contact, and relational contracts.