CALTECH SS 200 - Behavioral Organizational Economics

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ReferencesBehavioral Organizational EconomicsColin F. CamererDiv HSS 228-77CaltechPasadena CA [email protected] MalmendierGraduate School of BusinessStanford UniversityStanford CA [email protected], January 13, 2019. This paper was written for the Yrjö Jahnsson Foundation conference on economic institutions and behavioral economics. Ideas from the NBER Organizational Economics conference in March, 2004, particularly Bob Gibbons’s presentation, were useful, as were discussions with Chip Heath and Sendhil Mullainathanand Bengt Holmstrom’s discussion in Helsinki.0This essay is about how behavioral economics can be applied to organizations, and can also be enriched by thinking about the special economic questions associated with economic organization. Behavioral economics modifies economic theory to account for psychophysical properties of preference and judgment, which create normal limits on rational calculation,willpower and greed, and e.g. Mullainathan and Thaler, 2001; Camerer and Loewenstein, 2004). Thinking about organizations naturally extends this definition to include how socialization, networks and identity shape individual behavior in organizations (e.g., Akerlof and Kranton, 2003; Gibbons 2004). From a methodological perspective, behavioral economics is simply a humble approach to economics, which respects the comparative empirical advantages of neighboring social sciences and sees neighboring sciences as trading partners. The empirical regularity and constructs carefully explored by those neighboring fields are presumed to be an important input which should often trump the seduction of mathematically elegant economic theories which are empirically unmotivated. Progress has been made in behavioral economics by asking how behavior deviatesfrom the predictions of rational choice theory because of biologically-adaptive limits on willpower, calculating ability, perception and self-interest.1 One approach is to discover short-cut “heuristics” by the biases in judgment that reveal them. The biases-and-heuristics approach has been fruitful, but recent research has also proceeded in many newdirections which are worth noting. One direction is to move beyond behavioral economics as a list of effects (see McFadden, 1999, for an economists’-eye view), towarda more unified theory in which disparate effects are understood as the product of a small number of basic mechanisms (e.g., Kahneman, 2003). A second direction is to translate ideas about psychological mechanisms into formal language which can be plugged into models of the aggregate phenomena we most care about—contracting, organizational design, price distributions, asset price fluctuations, aggregate savings and consumption, 1 The guiding principle underlying much of this program of research (sometimes called the “heuristics and biases” approach) is similar to the way optical illusions and other “biases” have fruitfully guided research on perception: The biases put into sharp relief the underlying psychological mechanisms. This does not imply an endorsement that biases are common, economically large, or difficult to undo (“debias”), althoughthey sometimes are. Identifying heuristics by the biases they cause is simply an efficient way to learn about mechanisms. 1and so forth. A third direction is looking for implications of behavioral models in field data. A fourth direction is tapping ideas in psychology (such as attention, categorization, and neural mechanism) which were not part of the heuristics-driven thinking in the 1980’s.There is also a special challenge and opportunity from thinking about behavioral economics in organizations, both applying these ideas and extending them. Perhaps it is useful to note an analogy between how behavioral finance has developed as an academic discipline, and how behavioral organizational economics could develop. Until 1990 or so, finance was arguably the area of economics most hostile to the idea that psychological limits matter for the focus of the field’s attention—namely, stock price movements. Since then, there has been a dramatic shift in the amount of careful attention paid to behavioral ideas.This is surprising because it has been argued that large stock markets are the ultimate domain in which highly rational traders should limit the influence of those who make mistakes. So why did academic finance start to “misbehave”so fast? One reason was good data, which made it easy to test new behavioral theories against the rational incumbents. Another reason was the availability of a clear benchmark model (market efficiency) to argue with. Good data and a sharp benchmark enabled researchers to create a set of clear anomalies. Compiling such a list would be useful for behavioral organizational economics too.In fact, organizational economics is even riper than finance for using psychological ideas to understand regularities and make predictions. Because workers own their human capital, if they make mistakes allocating it nobody can short-sell their capital to exploit their mistakes. Adjustment to mistakes must therefore come from some other source than simply trading against a mistake. An interesting question is how organizations should be designed to repair these mistakes or exploit them, or organize around them if they represent genuine regret-free preferences rather than errors.2 Moving away from mistakes due to heuristics, a lot of psychology is involved when workers teamup in an organization—social comparison, changes in identity, camaraderie, attribution and diffusion of credit and blame, and so forth. This kind of psychology has played a 2 Bob Frank distinguishes mistakes you regret and those you don’t. Properties of preference like social comparison fall into the latter category. 2small role in behavioral economics in recent years but looms large when thinking about organizations. Our paper is divided into four parts. Each part poses a broad question and suggests some ideas. Little systematic knowledge has been cumulated on many of these topics. For those topics, the paper should be read as a research agenda rather than a review of what’s been learned. Section I lays out the basic single-activity risk-incentive conflict model and pointsout a list of psychological considerations which complicate the model. Section II notes that the simplest risk-incentive model does not particularly account or the fact that


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CALTECH SS 200 - Behavioral Organizational Economics

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