The formation of teams under incomplete information

Citation

Sherstyuk, Katerina (1995) The formation of teams under incomplete information. Dissertation (Ph.D.), California Institute of Technology. doi:10.7907/4cqc-pj45. https://resolver.caltech.edu/CaltechETD:etd-10192007-143628

Abstract

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Organizational forms such as task-oriented teams have often been proposed as a method to enhance the efficiency of a firm. Under asymmetric information, however, the costs of acquiring the information needed to improve efficiency may outweigh the efficiency gain and lead to lower profits. This dissertation analyzes profitability-efficiency trade-offs faced by a profit-maximizing principal who wants to select teams from a given group of heterogeneous agents to work on a number of projects, given that the principal has incomplete information about the agents' abilities.

The dissertation consists of two main chapters. In chapter one, we take a theoretical mechanism design approach to analyze the problem of the formation of multiple teams under different information structures and behavioral assumptions. We study feasible incentive-compatible (truth-revealing) individually rational mechanisms under both the dominant strategy and Bayesian Nash behavioral assumptions. Some attention is also paid to Nash equilibrium mechanisms. The chapter covers derivation of optimal mechanisms, efficiency analysis, and analysis of the principal's expected profit as a function of different types of environment and information structures. We find that if the principal has little or no information about the agents' private characteristics and the agents follow dominant strategy behavior, the principal may often run into losses in an attempt to discover the hidden information. Paradoxically, the loss occurs when the efficiency gains from team production are high and the competition among the agents is low. If the hidden information about each agent can be summarized as a one-dimensional type parameter, and if a prior distribution function of the agents' types is common knowledge among the agents and the principal, an expected-profit maximizing Bayesian equilibrium mechanism exists and is of the optimal auction form (Myerson, 1981). Moreover, the mechanism can be equivalently implemented in dominant strategies with no expected profit loss for the principal. Yet, the principal's profit often decreases with an increase in the number of projects. The findings suggest that, in profit-maximizing firms with low competition among the employees, efficient organizational forms may often be foregone in favor of profits.

In chapter 2 we consider, theoretically and experimentally, one specific type of the team formation mechanisms, a wage-demand mechanism, first suggested by Bolle (1991). Under these mechanisms, potential team members submit their wage demands to the principal and the principal chooses a team which gives her the highest profit - defined as the output of the team net of wages demanded by the team-members, and then pays all the employed agents their demanded wages. Bolle found that the principal's ability to detect and choose efficient teams among the profit-maximizing teams is essential for the existence of pure strategy Nash equilibria of the wage-demand games. We consider wage-demand mechanisms in a framework when the principal might have incomplete information about the agents' characteristics. In this case, the pure strategy Nash equilibria of the wage-demand game do not exist. However, there are [...]-Nash equilibria, which are close in efficiency and profitability to the Nash equilibria of the complete information game.

We present the results of experimental tests of the Nash and [...]-Nash behavioral hypothesis for the team-selection wage-demand games corresponding to complete and incomplete information cases. If the agents do follow the Nash equilibrium behavior, then the principal's information should not significantly affect the outcomes of the games regarding team's profitabilities and efficiencies. In his experimental investigation of the wage-demand games, Bolle found that the subjects often do not follow the competitive Nash equilibrium behavior, but engage in "tacit collusion." We test the robustness of Bolle's findings by introducing asymmetry into agent's productivity characteristics. We find that although some collusive tendencies are present in the subjects behavior, they are not sustainable; with repetition, the outcomes of the wage-demand games converge to the Nash equilibrium outcomes. However, we find that the two experimental treatments corresponding to the complete and incomplete information on the principal's part are not equivalent in the degrees of agents' competition and cooperation. In our experiments the agents were significantly more collusive when the principal had incomplete information, and the outcomes were less profitable for the principal. Thus, we once again confirm that information does matter for the profit-maximizing principal.

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