Abstract
Principals usually try to elicit the quality and behavior of agents from their performance. While sometimes success or failure in production does not provide accurate information about the agents, there may be activities not directly related to production that constitute a more precise signal. I show that, when agents face reputation concerns, introducing these activities after a success improves efficiency, while introducing them after a failure reduces efficiency. Hence, nesting activities in the right way may offer a cheap toolbox to provide incentives. As an illustration, I consider a model where reputation concerns drive the hiring decisions of managers in a firm and I show how scapegoating, an activity “nested” after failures in production, generates inefficiencies. While hiring efficient workers increases the probability of success, hiring less efficient workers provides a buffer against reputation loses from failures, since managers can blame them more easily.
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I would like to thank the editor, an anonymous referee, Christian Hellwig, David K. Levine, Joe Ostroy, Larry Samuelson, Vasiliki Skreta, Jeroen Swinkels, Bill Zame, and seminar participants at UCLA, Minnesota, and Washington University in St. Louis, for useful comments. The usual waiver of liability applies.
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Ordoñez, G. Reputation from nested activities. Econ Theory 52, 915–940 (2013). https://doi.org/10.1007/s00199-011-0672-0
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DOI: https://doi.org/10.1007/s00199-011-0672-0