## Abstract

This paper analyzes incentives for cronyism in politics within a political agency model with moral hazard. The analysis focuses on the institutional features, which define contractual and appointment procedures within political organizations. The institutional framework does not allow explicit contracting with politicians. They are motivated by reelection incentives and just need to guarantee that their team performance exceeds the minimum threshold required for reelection. This lowers the returns to bringing in efficient individuals in the politician’s team. Moreover, the nature of political promotions (such that a crony’s career is tied to that of his patron) leads to the alignment between political objectives of the politician and his cronies. This further increases the politician’s incentives to appoint less efficient friends.

### Similar content being viewed by others

## Notes

Entry “cronyism.” Oxford English Dictionary, John Simpson and Edmund Weiner (editors). Available online at http://oxforddictionaries.com/definition/english/cronyism (accessed August 14, 2013).

An exception is Egorov and Sonin (2011) who showed within a principal-agent framework that in dictatorships, in order to avoid betrayal, a weak ruler will hire mediocre but loyal subordinates.

Tasks within the political organization might be complementary, and then a failure to implement one task could lead to collapse of the whole organization. Analysis of such a task structure is left for future research.

The politician who leads the political organization not only appoints the subordinates, but also provides guidance and instructions and coordinates their work. However, the focus here is on a cronyism problem within the political organization. That is why it is assumed that the politician’s unique task is to choose subordinates.

Following the political agency literature, I assume that the voter forms her reelection strategy at the beginning of the game. The results would not change if the voter reoptimized just before the election. The reason is that the voting strategy is ex post optimal for the voter since the incumbent and the challenger are identical in all respects. Under the different timing, however, there would be other equilibria besides the one characterized here. According to Persson et al. (2000, p. 1133), the “timing assumption really amounts to a selection criterion: among the possible equilibria emerging if voters do not commit to a voting rule, we select the only one that survives under the timing spelled out above.”

Golden (2003, pp. 201 and 207).

This extension is available upon request.

Egorov and Sonin (2011) formalize a principal-agent model in which a dictator chooses a mediocre but loyal vizier to avoid treason.

## References

Alesina A, Tabellini G (2007) Bureaucrats or politicians? Part I: a single policy task. Am Econ Rev 97:169–179

Alesina A, Tabellini G (2008) Bureaucrats or politicians? Part II: multiple policy tasks. J Public Econ 92:426–447

Ashworth S (2012) Electoral accountability: recent theoretical and empirical work. Ann Rev Polit Sci 15:183–201

Austen-Smith D, Banks JS (1989) Electoral accountability and incumbency. In: Ordeshook PC (ed) Models of strategic choice in politics. University of Michigan Press, Ann Arbor

Banks JS, Sundaram RK (1993) Adverse selection and moral hazard in a repeated elections model. In: Barnett W, Hinich M, Schofield N (eds) Political economy: institutions, information, competition and representation. Cambridge University Press, New York

Banks JS, Sundaram RK (1996) Electoral accountability and selection effects. University of Rochester, Mimeo

Barro R (1973) The control of politicians: an economic model. Public Choice 14:19–42

Besley T, Coate S (2003) Elected versus appointed regulators: theory and evidence. J Eur Econ Assoc 1:1176–1206

Burkart M, Panunzi F, Shleifer A (2003) Family firms. J Financ 58:2167–2202

Caselli F, Gennaioli N (2013) Dynastic management. Econ Inq 51:971–996

Chami R (2001) What’s different about family businesses? mimeo

Egorov G, Sonin K (2011) Dictators and their viziers: endogenizing the loyalty-competence trade-off. J Eur Econ Assoc 9:903–930

Ferejohn J (1986) Incumbent performance and electoral control. Public Choice 50:5–26

Fields JA, Klein LS, Sfiridis JM (1997) A market based evaluation of the election versus appointment of regulatory commissioners. Public Choice 92:337–351

Formby JP, Mishra B, Thistle PD (1995) Public utility regulation and bond ratings. Public Choice 84:119–136

Freedman AE (1994) Patronage: an American tradition. Nelson Hall, Chicago

Golden MA (2003) Electoral connections: the effects of the personal vote on political patronage bureaucracy and legislation in postwar Italy. Br J Polit Sci 33:189–212

Guterbock TM (1980) Machine politics in transition. University of Chicago Press, Chicago

Hallock K (1997) Reciprocally interlocking boards of directors and executive compensation. J Financ Quant Anal 32:331–344

Heclo H (1977) A government of strangers: executive politics in Washington. Brookings, Washington, D.C.

Kramarz F, Thesmar D (2013) Social networks in the boardroom. J Eur Econ Assoc 11:780–807

Kuhnen CM (2009) Business networks corporate governance, and contracting in the mutual fund industry. J Financ 64:2185–2220

Levine DK, Weinschelbaum F, Zurita F (2010) The brother in law effect. Int Econ Rev 51:497–507

Maranto R (2005) Beyond a government of strangers: how career executives and political appointees can turn conflict to cooperation. Lexington, Lanham

Maskin E, Tirole J (2004) The politician and the judge: accountability in government. Am Econ Rev 94:1034–1054

Montgomery JD (1991) Social networks and labor-market outcomes: toward an economic analysis. Am Econ Rev 81:1408–1418

Persico N, Pueblita JCR, Silverman D (2011) Factions and political competition. J Polit Econ 119:242–288

Persson T, Roland G, Tabellini G (1997) Separation of powers and political accountability. Q J Econ 112:1163–1202

Persson T, Roland G, Tabellini G (2000) Comparative politics and public finance. J Polit Econ 108:1121–1161

Prendergast C, Topel R (1996) Favoritism in organizations. J Polit Econ 104:958–978

Scoppa V (2009) Intergenerational transfers of public sector jobs: a shred of evidence on nepotism. Public Choice 141:167–188

Simpson J, Weiner E (1989) Oxford english dictionary. Oxford University Press, Clarendon

Smart SR (1994) The consequences of appointment methods and party control for telecommunications pricing. J Econ Manag Strategy 3:301–323

Taylor CR (2000) The old-boy network and the young-gun effect. Int Econ Rev 41:871–891

## Acknowledgments

I am grateful to Luis Corchón, Montserrat Ferré, Kai Konrad, Humberto Llavador, Massimo Morelli, an anonymous referee, an associate editor, and John Duggan, the managing editor, for helpful comments, suggestions and encouragement. I also thank seminar and conference participants at several institutions for useful comments and suggestions. The grant from Karin-Islinger-Stiftung foundation and project grant ECO2011-25203 from the Spanish Ministry of Science and Innovation are gratefully acknowledged. An early version of this paper circulated under the title “Cronyism in Business, Public Sector and Politics”. The usual disclaimer applies

## Author information

### Authors and Affiliations

### Corresponding author

## Appendices

### Appendices

Throughout the Appendix, \(F\) will be used to denote the normal distribution function, and \(f\) for the corresponding density.

### Appendix 1: Subordinates’ maximization problem

The first-order conditions (FOCs) with respect to subordinate \(i\)’s support \( s_{i}\ge 0\) for the politician are

The second-order conditions (SOCs) with respect to \(s_{i}\) hold. The FOCs yield equilibrium levels of support \(s_{i}^{p}\), which depend on a number of cronies \(m\) appointed by the politician:

The FOCs with respect to subordinate \(i\)’s effort \(a_{i}\in \left[ 0, \overline{a}\right] \), taking reelection threshold \(p\in \mathbb {R} \) as given, are

The second derivatives with respect to \(a_{i}\) are

If (6.3) evaluated at critical points characterized by the FOCs (6.2) are strictly negative then the SOCs of the subordinates’ maximization problem are satisfied. In this case, the assumption that the upper bound of the set of efforts, \(\overline{a}\), is large ensures that the best response functions are characterized by the FOCs (6.2). The subordinates’ best response functions are continuous functions from a nonempty, compact, convex set, \(\left[ 0,\overline{a}\right] \), into itself. Thus, the standard existence results are applied to establish the existence of equilibrium efforts \(a_{i}^{p}\), \(i=1,...,n\), characterized by the FOCs ( 6.2).

However, if (6.3) evaluated at critical points characterized by the FOCs (6.2) are non-negative then corner solutions are to be considered as the FOCs (6.2) do not yield maximum. If a subordinate exerts maximal level of effort \(\overline{a}\) then his net payoff from holding office becomes

If he makes no effort then his net payoff is

The assumption that the upper bound of the set of efforts, \(\overline{a}\), is large guarantees that the latter is greater than the former. Thus, \( a_{i}^{p}=0\) if the corresponding SOC does not hold.

### Appendix 2: Politician’s maximization problem

The FOCs (6.2) and the second derivatives (6.3) of the subordinates’ maximization problem imply that both in interior optima and in corner solutions, all cronies exert the same level of effort, denoted by \( a_{C}^{p}\), and all experts exert the same level of effort, denoted by \( a_{E}^{p}\). Then substituting \(s_{i}^{p}\) defined in (6.1) into the politician’s objective function \(\Pi \left( m\right) \) yields

The FOC with respect to \(m\) is

The second derivative with respect to \(m\) is

If (6.5) evaluated at a critical point characterized by the FOC (6.4) is strictly negative then the SOC of the politician’s maximization problem is satisfied and therefore the FOC (6.4) yields a number of cronies which maximizes the politician’s objective function \(\Pi \left( \cdot \right) \) for a given reelection threshold \(p\). Then an equilibrium number of cronies \(m^{p}\) is given by

where \(m\) is characterized by the FOC (6.4), \(\left\lfloor \cdot \right\rfloor \) denotes the floor function and \(\left\lceil \cdot \right\rceil \) the ceiling function.

However, if (6.5) evaluated at a critical point characterized by the FOC (6.4) is non-negative then corner solutions are to be considered as the FOC (6.4) does not yield maximum. If the politician delegates tasks only to cronies then his utility is

If he appoints only experts then his utility becomes

Note that \(\Pi \left( n\right) >\Pi \left( 0\right) \) for \(n\ge 1\). Thus, \( m^{p}=n\) if the SOC does not hold.

### Appendix 3: Proof of proposition 1

The voter chooses \(p\) to maximize

where \(a_{C}^{p}\) and \(a_{E}^{p}\) are either characterized by the FOCs (6.2) or equal to \(0\) (either both or one of them). \(m^{p}\) is either given by (6.6) or equal to \(n\).

First, I consider the case in which both \(a_{C}^{p}\) and \(a_{E}^{p}\) are characterized by the FOCs (6.2) and \(m^{p}\) is given by (6.6). The FOCs (6.2) yield

while the FOC (6.4) yields

Substituting (6.8) and (6.9) into (6.7) and rearranging yields

which increases with \(\overline{f}_{\widehat{\varepsilon }}\equiv f_{ \widehat{\varepsilon }}\left( p-m^{p}a_{C}^{p}-\left( n-m^{p}\right) a_{E}^{p}\right) \). The voter therefore chooses \(p\) to maximize the density function \(f_{\widehat{\varepsilon }}\left( p-m^{p}a_{C}^{p}-\left( n-m^{p}\right) a_{E}^{p}\right) \), which takes the maximum value of \(f_{ \widehat{\varepsilon }}\left( 0\right) =\frac{1}{\sqrt{2\pi n}\sigma }\) at \( p=m^{p}a_{C}^{p}+\left( n-m^{p}\right) a_{E}^{p}\). Substituting \( p=m^{p}a_{C}^{p}+\left( n-m^{p}\right) a_{E}^{p}\) into (6.8) and (6.9) yields the equilibrium levels of subordinates’ efforts \(a_{C}^{*}\) and \(a_{E}^{*}\)

and the number of cronies \(m\) which maximizes the politician’s objective function

Since \(\Pi \left( \left\lfloor m\right\rfloor \right) <\Pi \left( \left\lceil m\right\rceil \right) \) then the equilibrium number of cronies \( m^{*}\) (bounded by \(n\)) is equal to

The equilibrium reelection threshold (as well as the expected performance of the politician’s team) is given by

Substituting the equilibrium efforts, number of cronies and reelection threshold into the second derivatives (6.3) and (6.5) yields

which are strictly negative. It follows that the SOCs of the subordinates’ and politician’s maximization problems are satisfied.

I turn now to the case in which both \(a_{C}^{p}\) and \(a_{E}^{p}\) are characterized by the FOCs (6.2) and \(m^{p}=n\). The voter chooses \(p\) to maximize

which increases with \(f_{\widehat{\varepsilon }}\left( p-na_{C}^{p}\right) \) . The voter thus chooses \(p\) to maximize the density function \(f_{\widehat{ \varepsilon }}\left( p-na_{C}^{p}\right) \). To ensure that the corner solution \(m^{p}=n\) is an equilibrium of the politician’s maximization problem, the second derivative of the politician’s maximization problem (6.5) evaluated at a critical point characterized by FOC (6.4) has to be non-negative. This implies that \(-f_{\widehat{\varepsilon } }^{\prime }\left( p-ma_{C}^{p}-\left( n-m\right) a_{E}^{p}\right) \) with \(m\) characterized by FOC (6.4) has to be strictly positive implying \( p-ma_{C}^{p}-\left( n-m\right) a_{E}^{p}>0\). After tedious algebra, one might show that \(\max _{p>ma_{C}^{p}+\left( n-m\right) a_{E}^{p}}\left[ f_{ \widehat{\varepsilon }}\left( p-na_{C}^{p}\right) \right] <f_{\widehat{ \varepsilon }}\left( 0\right) =\frac{1}{\sqrt{2\pi n}\sigma }\). It follows therefore that the expected performance of the political organization in this case is strictly lower than in the case in which \(m^{p}\) is characterized by the FOC (6.4). Thus, this is not an equilibrium.

Finally, I consider the case in which either \(a_{C}^{p}=0\), or \(a_{E}^{p}=0\) , or both \(a_{C}^{p}=a_{E}^{p}=0\). To guarantee that this corner solution is an equilibrium of the subordinates’ maximization problem, the corresponding second derivative evaluated at the critical point has to be non-negative. Therefore, the voter chooses \(p\) from the set in which the corresponding second derivative is non-negative. But in this case, the expected performance of the political organization is strictly lower than in the case in which the subordinates’ efforts are characterized by the FOCs (6.2 ). Thus, this is not an equilibrium.

Then the unique equilibrium of the voter’s maximization problem is given by