Strong-Man Economics

16 October 2008 at 4:02 am Lasse Leave a comment

| Lasse Lien |

Here is an interesting paper from the NBER working paper series. Bolton, Brunnermeier and Veldkamp show that it can be optimal for organizations to hire an irrational manager. Irrational in the sense that the manager is less likely to revise strategy as new information becomes available (i.e. is resolute).

The basic setup is that in the first stage the manager receives a signal about the state of the environment and formulates an initial strategy. In the second stage the organizational members act, deciding how closely the will align their actions to the proposed strategy. The actions of individual members are chosen given their knowledge about the manager’s type and a private signal about the environment. The latter may lead them to anticipate a revision of the strategy. In the third stage the manager receives a second signal about the state of the environment, and in the fourth and final stage the leader decides on the final strategy and payoffs are realized.

The essence of the argument is that the less likely the manager is to revise strategy, the better the coordination of the individual members actions. So there is a time-consistency problem that is reduced when a manager is resolute in the sense of not updating as much as optimal adaptation would suggest, and this is known by followers. The paper also supplies interesting discussions of what happens if the leader can commit to not revising strategy (instead of being a resolute “type”), and the cost of resoluteness if the manager can learn from followers.

One can always quibble about the assumptions made in game-theoretic models. An example here would be the assumption that there is no coordination problem after the manager announces his/her final strategy, only in the period between the initial strategy announcement, and the arrival of the second signal about the environment. But definitely a good read, which nicely captures the trade-off between coordination and adaptation. Hereby recommended (the paper, that is, not the hiring of irrational managers or politicians).