«Oxford University Press is collaborating with JSTOR to digitize, preserve and extend access to Journal of Law, Economics, &Organization. ...»
The behavior of the supervisor as an advocate for the agent may shed some light on the well-known and intriguing fact that positive reinforcement is more reliable than negative reinforcement.25 Rewards work better than punishments. The usual, psychological explanation for this phenomenon is the traumaassociated with punishments (issue of framing). It is harder to come up with an economic interpretation. Economists are not used to distinguishing rewards and punishments (punishments are just negative rewards). The theoretical model of part 3 shows that there may be an economic explanation as well, if one views organizations as a network of groups. For instance, a supervisor who is not willing to bear any income risk intervenes only to raise the agent's wage (in state 1), never to lower it. Thus, the supervisor'sdegree of freedom (object of intervention) is to reward the agent.26 Except in the
25. See, e.g., Katz and Kahn (1978: 310).
26. If the supervisor is not infinitely risk-averse, the idea that rewards work better than punishments can still be formalized, albeit not in such a stark way. The supervisor needs no special incentive to reveal the environment is unfavorable(state 1), in the sense that the coalition
extreme case of an infinitely risk-averse supervisor, there is still scope for the supervisory function if the agent can produce the verifiable information himself. In the absence of a supervisor, there is no way to induce the agent to reveal that the environment is favorable(while he is always willing to demonstrate that the environment is unfavorable).A supervisorwho is willing to bear some income risk can be given incentives to reveal that the environment is favorable, as long as the penalty imposed on the agent by this announcement is not so high that the agent bribes the supervisor not to reveal. (An alternative and more technical way to approachthis result is to notice that the presence of a supervisor increases the set of contingencies over which an insuranceincentive contract can be signed with the agent.) In some cases, the agent may not be in a position to produce verifiable informationhimself. He may not be able to defend his case clearly ("lawyer's syndrome") or to provide quality tests. Alternatively, he may lack the time to do so.27
4.2. WHO COLLUDESWITHWHOM?
The reader might be misled by my emphasis on the supervisor-agentcoalition and infer that (effective) coalitions naturallyarise between the lower tiers of a vertical structure. The problem with this inference is that the conventional ordering in vertical structures is based on criteria that may not capture the issue studied here (for example, the ordering may stem from the initial distribution of authority or residual rights of control). Even though coalitions naturallyformbetween a "supervisor"and an "agent,"the notions of"supervisor" and "agent" may not fit conventional ordering.
For instance, the ordering of the hierarchies justice/police/convict and colonel/captain/conscriptmay not reflect their structures of information. One may think of instances in which the agent is the police or the captain, the principal the convict or conscript, and the supervisor the judicial system or the colonel. With this reordering, the agent may take an action that affects the principal, and the supervisor may check the agent's action. Thus, a coalition can form between the judicial system and the police against the convict, and between the colonel and the captain against the conscript. This means the incentive constraint is not binding. By contrast, in state 4, the supervisor reveals that the environment is favorable only if his wage increase associated with the disclosure of information is at least equal to the corresponding reduction in the agent's wage (the coalition incentive constraint is binding).
27. The supervisor, from his dual function (planning, coordinating, advising, etc.) may devote more time to learning about outside units (shops, firms). If some other units are subject to productivity shocks that are statistically correlated with the agent's activity, the performance of these units can be used as a yardstick to infer the agent's behavior. Another possibility is that the supervisor supervises several agents. A common productivity shock affecting the agents may give rise to a free rider problem between the agents: each agent may be able to gather the evidence about the common shock and discuss it with upper tiers of the hierarchy, but he would prefer other agents to offer their time to do so.
theory is consistent with the existence of coalitions between members of what is traditionally called "upper tiers." The moral is that the identification of effective coalitions in an organization requires a careful consideration of the information structure. Similarly, a party may collude with different parties depending on the issue.28
4.3. THE LENGTHOF RELATIONSHIPS
Giving parties contract incentives or forcing them to have a long-run relationship has some desirable effects. First, as Williamson (1975) has forcefully argued, long-run relationships help foster the accumulation of specific assets.
Second, as emphasized in the repeated moral hazard literature, repetition alleviates incentive problems (if the agent does not have access to perfect capital markets). On the other hand, it has been recognized that contracts should leave some flexibility for mutually advantageous "breaches."29In this section, I remark that the possibility of collusion suggests an alternative explanation of short-run relationships.
Collusions require side-transfers. As discussed in part 2, some types of transfers (monetary, personal interaction) may enforce coalitions in shortrun relationships. The latter can also be enforced by a mutual threat (each member of the coalition threatens to release some piece of information that would be detrimental to the other member). Often, however, transfers and threats are not simultaneous: a party does a favor for the other party, who implicitly or explicitly promises to reciprocate later. The enforcement mechanism is then associated with repetition.
Keeping relationships short has the advantage of restricting side transfers and, thus, of limiting the influence of coalitions in organizations. As Kreps et al. have shown, cooperation between two parties at any given time increases with the time horizon of their relationship. It would be desirable to develop models of reputation that explain the common observation that the extent of collusion between two parties tends to increase over time. I expect such a formalizationto follow one of the following two intuitive lines. First, trust may be slow to develop and the stakes of a cooperative behavior may accordingly rise over time. Higher stakes can be offered when one becomes reasonably sure that the other party is interested in cooperation.30 Second,
28. In my model, the supervisor might share with the owner of the firm some information about demand for the product, say (like in the implicit contract literature). The supervisor then becomes a supervisor for the (so-called) principal and may collude with him not to release this information to the (so-called) agent. At the same time, he may collude with the agent regarding the release of the productivity information.
29. This aspect has been particularlyemphasized by Aghion and Bolton in their reconsideration of the market foreclosure doctrine. In a somewhat different vein, see also Harris and Holmstrom's study of the sampling problem between two parties who, over time, lose information about the value of their relationship.
30. For a promising start on this, see Sobel's introduction of a stake into the KrepsMilgrom-Roberts-Wilson model.
and this argument is more specific to coalitions in organizations,past collusion may enforce current and future collusion. Once parties (for example, the supervisor and the agent) have started colluding, each possesses threats against the other in case of a breach. Disclosure by one party of information detrimental to the other party usually prompts immediate retaliationthrough release by the latter of information detrimental to the former.31This mutual blackmail, which makes the breakdown of collusion costly, forces the parties into a coalition to keep on colluding.32 There is some evidence that organizations give their members (especially at the managerialand supervisory levels) incentives to switch jobs within the organization.33Sometimes they even require it. In France one of the functions of the "GrandsCorps"of civil servants is to provide decision makersand analysts who are mobile and fairly independent of pressures that come from inside the organizationswith which they are working (because of their job and wage security as well as their mobility).
Another piece of evidence is the use of consulting firms to collect information. The latter are expensive and in many cases are limited in their access to information. However, their members have a short-run relationship with each firm for which they are working and therefore are almost (hidden) transfer-free.34,35 Similarly, outside recruiting may bring new blood to an organization, even when the new employee does not have superior ability or knowledge. (New employees are less subject to coalitional pressures because they do not yet know whom to trust).36
As a last example, let me point out that the advantage of a journal's anonymous reviewing process is that the referee-author relationship amounts to a one-shot relationship.
THE EMERGENCEOF BUREAUCRACIES
4.4. RULES VS. DISCRETION:
The design of coalition-proofschemes has two facets. Should the principal rely on the supervisor'sreport to reward or punish the agent? Should the supervisor have discretion on the agent's reward or punishment? I take these two facets to be equivalent for the purpose of my single supervisor framework.
The main feature of a rule is that it leaves no discretionary power to its enforcer. In other words, a rule prevents the use of the enforcer's decentralized information. Rules are thus impersonal (suppress face-to-face relationships) and involve a loss of information. Bureaucracies are organizations mainly run by rules. The role of rules has been emphasized by, among others, Weber, Crozier, and Arrow.
The classical principal/agent paradigm in economics is already concerned, if not with rules, at least with limits on the discretionary power left to the informed party. In this model, the agent is simultaneously decision maker (because of his superior information)- and involved party. Therefore, he cannot be fully trusted and must be given an "incentive compatible" reward scheme (in some extreme cases, the principal may demand something like a profit or production target-in technical terms, may induce pooling or bunching-which is the theoretical analog of a rule). The idea that one may want to limit the discretion of a party who is simultaneously "judge and party" is well understood. By contrast, the observation that a party having relevant informationto assess or affect other parties cannot fully be trusted to use this informationto serve the goals of the organization may be more central to the reflections on rules and bureaucracies.
As we saw, collusion creates hazards to soft information, and even to a part of hard information (see, for example, proposition 4). The nonreliability of informationtransmitted by a supervisor naturallyleads to the abandonment of this information or, equivalently, to the absence of supervisory discretion.
For example, a foreman may not be entitled to allow a worker to be absent even if only he has the information relevant to this decision. More generally, foremen have almost no initiative as to personnel management and organization.37
If coalitions indeed foster bureaucratictendencies, the previous reflections on the factors that influence the formationof coalitions ought to be relevant to explain why some organizations are more bureaucratic than others (that is, more run by rules). Let me offer some conjectures on this.