By Eller College
Knowledge is power, but blissful ignorance can pay off, according to a new paper from associate professor of economics Mark Stegeman. The paper appears in the spring issue of The RAND Journal of Economics.
Economists rarely study leadership, but in his new paper “Leadership Based on Asymmetric Information,” Stegeman and co-author Mana Komai of Saint Cloud State University use game theory to tackle two classical problems that organizations face: incentive issues, or how to motivate people to work hard; and coordination problems, or how to get people to work together.
“Existing management literature suggests various ways to address these problems, but the two main themes are redesigning contracts and improving everyone’s information,” says Stegeman. “This paper goes in the opposite direction. Instead of using complex contracts to improve incentives, we leave contracts in the background and restrict the distribution of information.”
Stegeman and Komai set up a formal game that represents a simple organization and found that when the incentive for people to “free ride” is moderate, giving all the information to only one person — the leader — leads to more efficient outcomes than giving it to everyone.
“That’s because it’s harder for uninformed workers to know when to shirk,” Stegeman says. “When only one person gets the information and acts, the others observe the action and can either join in, or shirk. The followers don’t know the leader’s information and whether she is acting to pursue a high-payoff or a marginal project. So followers can be ‘tricked’ into joining projects which they would individually prefer to avoid, but they collectively benefit from their ignorance, and they understand that.”
The key, he says, is for the leader to maintain credibility with the followers. In his paper, one kind of credible leader is a “high-cost leader,” who is reluctant to act. When this leader does choose to pursue a project, the followers will conclude that the project has a high expected payoff and be willing to follow the leader.
“We show that superficial notions of what makes a good leader — or a good follower — may not always be correct,” Stegeman says. “In some cases, he who knows less works more, and he who leads least leads best.”
The paper also provides surprising insights into executive compensation. “What’s interesting is that we haven’t given the leader a special contract. Often executive contracts tie CEO compensation to manipulable measures of performance, which can lead to fraud,” Stegeman says. “Our model is unusual in showing that a credible leader’s incentives can be improved through her increased informal authority rather than through her compensation.”
The catch is that the model is based on a simple firm. “The larger the organization, the harder it is for a leader to maintain credibility,” Stegeman explains. “The leader’s increased leverage can itself destroy her credibility by tempting her to pursue too many projects. One way to correct this is to dilute that leverage by having more than one leader.”
Stegeman and Komai push the model further, giving each follower the option to learn the leader’s information, at the same cost. In many cases this symmetric situation still leads to a unique leader. “The investment in information makes sense for a leader who effectively directs everyone, but not for a follower who directs only himself,” he says.
The model can be applied to political action. “For example, a leader who supports a candidate rarely mentions the candidate’s weaknesses,” Stegeman says. “The support that his endorsement attracts from other activists may be a public good that benefits all, although many might withhold their support if they knew that the candidate was only marginally better than his opponents. The followers benefit from their own ignorance of the candidate’s weaknesses, because that inhibits shirking.”