"Overconfidence by Bayesian Rational Agents", Management Science, 57 (5), May 2011, 884-896 [ pdf]
Online Appendix

"On the Origin of Shared Beliefs (and Corporate Culture)," Rand Journal of Economics, 41 (4), Winter 2010, 617-648 [pdf]
Earlier working paper April 2004[pdf]

"Culture Clash: The Costs and Benefits of Homogeneity," Management Science, 56 (10), October 2010, 1718-1738 [pdf]
Earlier working paper 2007 [pdf]

"Interpersonal Authority in a Theory of the Firm", American Economic Review, 100, March 2010, 466-490 [pdf]
Earlier working paper [pdf]

"Disagreement and the Allocation of Control", Journal of Law, Economics, and Organization, 26(2), August 2010, 385-426 [pdf]

"Managing Know-How" (with Deishin Lee) , Management Science, 56 (2), February 2010, 270 – 85 [pdf]

"Authority versus Persuasion," American Economic Review Papers and Proceedings, 99, May 2009, 448 – 53 [pdf]

"Rational Overoptimism (and Other Biases)", American Economic Review, 94, September 2004, 1141-1151 [pdf]
Earlier working paper "Skill or Luck: Biases of Rational Agents" [pdf]

"Organizational Beliefs and Managerial Vision," , Journal of Law, Economics, and Organization, 21 (1), Spring 2005, 256-283 [pdf]
Earlier working paper versions : July 2001[pdf] ; October 2002[pdf]

"Essays on the Managerial Implications of Differing Priors," May 2001, PhD Dissertation, Stanford Business School [pdf]

"Human Capital and Corporate Governance," with John Roberts, in Corporate Governance: A Volume in Honor of Horst Albach, J. Schwalbach ed., Berlin, Springer Verlag, 2000

Working Papers

"A Formal Theory of Strategy," December 2013, working paper [pdf]

"Strategy and the Strategist: How it Matters who Develops the Strategy," December 2013, working paper [pdf]

"A Theory of Explicitly Formulated Strategy", May 2012, working paper [pdf]

"The Cost of Incentives under Disagreement: Too Motivated ", March 2007, working paper [pdf]
Earlier working paper version: "Too Motivated?", June 2005, working paper [pdf]

"The Limits of Authority: Motivation versus Coordination", June 2006, working paper [pdf]

"Disagreement and Information Collection", April 2002, working paper [pdf]

"Equity Participations, Hold-up, and Firm Boundaries," February 2002, working paper [pdf]

"Shareholder Interests, Human Capital Investments and Corporate Governance," with John Roberts, April 2000, Stanford GSB Working Paper 1631 [pdf]

"The Threat of Bankruptcy Can Eliminate the Hold-up Problem," July 2000, working paper [pdf]

Work in Progress

"Rules, Reputation, and Firm Performance"

"The Problem with Persuasion"

"Disagreement versus the Coase Theorem, with an Application to Firm Boundaries"

"An Economic Theory of the Firm as a Legal Entity"

"The Value of Being Vague"

A Theory of Explicitly Formulated Strategy

When a CEO tries to formulate `a strategy', what is she looking for? What exactly is `a strategy', why does it matter, and what are its properties?
This paper defines an explicitly formulated `strategy' as the `smallest set of choices and decisions sufficient to guide all other choices and decisions,' which formally captures the idea of strategy as a plan boiled down to its most essential choices. I show that this definition coincides with the equilibrium outcome of a game where a person can -- at a cost -- look ahead, investigate, and announce a set of (intended or actual) choices to the rest of the organization. Strategy is also -- in some precise sense -- the smallest set of decisions that needs to be decided centrally to ensure that all decisions are consistent (by giving a clear direction).
The paper analyzes what characteristics make a decision `strategic' and when and how having a strategy creates value, including when a strategy `bet' can create value. It shows how understanding the structure of strategy may enable a strategist to develop the optimal strategy without a comprehensive optimization. And it derives some broader organizational implications.

Interpersonal Authority in a Theory of the Firm

This paper develops a theory of the firm in which a firm's centralized asset ownership and low-powered incentives give the manager, as an equilibrium outcome, interpersonal authority over employees (in a world with open disagreement). The paper thus provides micro-foundations for the idea that bringing a project inside the firm gives the manager control over that project, while explaining concentrated asset ownership, low-powered incentives, and centralized authority as typical characteristics of firms. The paper also leads to new perspectives on the firm as a legal entity and on the relationship between the Knightian and Coasian views of the firm.

The Cost of Incentives under Disagreement: Too Motivated

This paper identifies a new cost of pay-for-performance incentives when principal and agent may disagree on the optimal course of action. In particular, pay-for-performance gives the agent a reason to disobey the principal, and thus act against his principal's interests, when the two of them disagree. In other words, high-powered incentives may decrease the agent's `zone of acceptance' (Simon 1947) when principal and agent disagree. As a consequence, disagreement forces a trade-off between motivation and authority.
This effect has a number of implications. First, and most importantly, agents who are subject to authority will have low-powered incentive pay. Second, intrinsically motivated agents with strong views will be more likely to disobey and thus, in equilibrium, less likely to be subject to authority and more likely to be independent entrepreneurs. A surprising result is that an increase in intrinsic motivation may actually decrease all players' expected utility. Finally, subjective performance pay will be optimal when (and only when) the principal tries to exert interpersonal authority, and not just second-best when the outcome is difficult to measure or contract. I also discuss some potential implications for the theory of the firm.
Through this analysis, the paper identifies an important difference between differing priors and private benefits (or private information): with differing priors, pay-for-performance may create agency problems rather than solving them.

Managing Know-How

We study how firms can use a knowledge management system to optimally leverage employee-generated know-how. In particular, we consider the following practical strategic questions for the manager of a knowledge-intensive firm: should her firm develop a formal knowledge system? And if so, how should it be managed, particularly in terms of what information to record?
We find that firms benefit more from a knowledge system when they are larger, face the same issues more frequently, have higher turnover, and face problems about which there is less general knowledge. In terms of what information to record, a key insight is that recording moderately successful practices can be counter-productive, since doing so may inefficiently reduce employees' incentives to experiment. This ``strong-form competency trap'' forces firms into an exploration-exploitation trade-off. Firms that value a knowledge system most should also be most selective in recording information. We further find that recording successes is more valuable than recording failures, which supports firms' focus on best practice. Beyond these main principles, we also show that it may be optimal to disseminate know-how on a plant-level but not on a firm-level, and that recording back-up solutions is most valuable at medium levels of environmental change.

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, 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 is true when effort and decisions are 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.


Disagreement and the Allocation of Control

This article studies the allocation of control when there is disagreement—in the sense of differing priors—about the right course of action. People then value control rights since they believe that their decisions are better than those of others. More disagreement (due to, e.g., fundamental uncertainty) increases the value that players attach to control. The article shows that all income and control of a project should then be concentrated in one hand: income rights should go more to people with more control since such people value income higher (because they have a higher opinion of the decisions made); control rights should go more to people with more income since they care more (and believe that they make better decisions). Different projects may be optimally ‘‘owned’’ by different people. Furthermore—with residual income exogenously allocated—complementary decisions should be more co-located, whereas substitute decisions should be more distributed. Confident people with a lot at stake should—in a wide range of settings—get more control. (JEL D7, D8, L2, M1)

Rational Overoptimism (and Other Biases)

Rational agents with differing priors tend to be overoptimistic about their chances of success. In particular, an agent who tries to choose the action that is most likely to succeed, is more likely to choose an action of which he overestimated, rather than underestimated, the likelihood of success. After studying the comparative statics of this mechanism, I show that it also causes agents to attribute failure to exogenous factors but success to their own choice of action, to disproportionately believe that they will outperform others, to overestimate the precision of their estimates, and to overestimate their control over the outcome. (JEL A12, B49, C70, D81, D84)


Skill or Luck

This paper shows why, in a world with differing priors, rational agents tend to attribute their own success more to skill and their failure more to bad luck than an outsider. It further shows why each agent in a group might think he or she is the best, why an agent might overestimate the control he has over the outcome, and why two agents' estimated contributions often add up to more than 100%. Underlying all these phenomena is a simple and robust mechanism that endogenously generates overoptimism about one's own actions. The paper also shows how these biases hinder learning and discusses some implications for organizations.


Organizational Beliefs and Managerial Vision

Can managers have an impact on their firm that goes beyond their direct actions and decisions? This paper shows that a manager with strong beliefs about the right course of action for the firm will attract, through sorting in the labor market, employees with similar beliefs. This alignment of beliefs gives direction to the firm and has important implications for incentives and coordination. The paper then defines vision, in accordance with the management literature, as such strong beliefs about the right course of action and shows that, because of this sorting effect, it is often optimal for a board to hire visionary managers. It also discusses succinctly the link with corporate culture.


On the Origin of Shared Beliefs (and Corporate Culture)

This article shows how corporate culture, in the sense of shared beliefs and values, originates (often unintentionally) through screening, self-sorting, and manager-directed joint learning. It shows that such culture will be stronger among more important employees and in older and more successful firms where employees make important decisions and the manager has strong beliefs. It further shows how a manager's beliefs influence culture, how culture persists despite turnover, and why the suggested link between culture and performance may be a case of inverse causality. It finally shows that, from an outsider's perspective, organizations may tend to over-invest in corporate culture.

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 shared beliefs.

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.


Disagreement and Information Collection

This note shows that disagreement, in the sense of differing priors, may increase the incentives to collect information when two agents work on a joint project. The reason is that each agent believes that new data will confirm his own beliefs and thus `convince' the other agents to do what the focal agent thinks is right.


Equity Participations, Hold-up, and Firm Boundaries

Equity participations affect the hold-up problem in two ways. On the one hand, they allow to reduce the externality that is created ex-post by hold-up. On the other hand, they change the bargaining positions by partially internalizing the threat of walking away from the bargaining. It turns out that, for firms that are run by professional managers and that bear the costs of the relevant investments, the bargaining effect is the more important. In some cases, it even allows to achieve complete efficiency. In particular, with one-sided dependency, a 50% participation gives full efficiency. In the case of bilateral dependency, the unique efficient solution is equivalent to a merger. This basis for determining optimal firm boundaries is essentially one of incentive design, as suggested by Holmstrom (1999), rather than property rights. The theory also shows how joint ventures can sometimes realize the benefits of equity participations, while avoiding some concurrent problems.


Shareholder Interests, Human Capital Investments and Corporate Governance (with John Roberts)

This paper shows that the pursuit of shareholder interests may require ceding a role in corporate governance to employees, in order to motivate their investing in firm-specific human capital. Doing so becomes more attractive as these investments increase in importance. This result also bears on the debate about reforming European and Japanese governance systems in the direction of the American system, reducing employees’ influence. In this context, we present a model on the optimal choice of governance systems, along ideas suggested by Holmström.


The Threat of Bankruptcy Can Eliminate the Hold-up Problem

This paper shows that hold-up inefficiencies disappear completely when the firm making the specific investments would go bankrupt if no ex-post agreement were reached. The result can explain the efficiency of close alliances and the use of option-like rewards (and layoffs) as incentive mechanisms. The model also shows how sunk investments  sometimes do play a role in the ex-post bargaining, when firms have limited liability.