11/30/2013

Identity and organizations

Literature review of a seminal paper by George Akerlof and Rachel Kranton.
Inculcating in employees a sense of identity and attachment to the organization may do good to the well-functioning of the whole group. \

Monetary incentives remain a blunt instrument.
(1) Compensation schemes are based on observable variables. But these variables are at best a proxy of effort and ability of the employees. Information asymmetry still exists, incurring moral hazard and adverse selection.
(2) Monetary compensation may have negative effects. For example, employees may overperform on well rewarded tasks and underperform on poorly rewarded tasks. Workers may also backstab one another to be the best relative performer.

Vilfredo Pareto noticed that much of the utility depends not only on what economists usually think of as tastes, but also on norms as to how people think that they and others should behave. Another observation is how people should behave depends upon the particular situation.

The term identity is used to describe a person's social category---gender, race, group affiliation...It is also used to describe a person's self-image. IN a model of utility, a person's identity describes gains and losses in utility from behavior that conforms or departs from the norms for particular social categories in particular situations. In this model, individuals' utility function can change because people internalize norms at different time periods, triggered by different actions. 

We add a new variable, identity to basic principal-agent model.
In this new model, the worker's utility varies with his category as either an insider or an outsider, and his utility depends on his effort from the ideal for his respective social category, depending on his identity and situation.

Effect of adding this new variable:
When the agent sees himself as an insider, he max his identity utility by exerting the high effort, and thus he doesn't need a large difference in monetary rewards to induce him to work hard. If the agent sees himself as an outsider, then he requires a higher wage differential to compensate him for the utility he loses when he works in the interests of the firm.

The firm may have incentive to change the agent from an outsider to an insider.

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