[MUSIC PLAYING] YI CHEN: Hello. My name is Yi Chen. I am an assistant professor of economics at SC Johnson Graduate School of Management, which is part of the SC Johnson College of Business.
One of my research fields is the design of correcting mechanisms when people's incentives are distorted by hidden information. So let me introduce one paper in this field. We know that conflict of interests often arises between the headquarters of a firm and a department manager when they have different goals. Say the headquarters always wants to allocate the right amount of resources while the department manager desires as much as possible due to their personal benefits. So this problem is actually further aggravated by information asymmetry because while the headquarters has the power to determine the resource allocation, the manager has the exclusive local knowledge about how much resources is truly needed and therefore can misrepresent it.
So the research question is then how should the headquarters optimally balance the necessity of resource allocation against the potential misinformation from the department manager in a long-term relationship. And the immediate observation is that the headquarters should not give the manager whatever is requested because otherwise the manager will always inflate the report and request too much.
Therefore, in order for the manager not to exaggerate the need for resources, the headquarters should give them a quota over time so that if more resources are cashed out today, less will remain for future use. Just the quota alone is not enough because the headquarters also has to mete out how much resources to allocate in all circumstances.
If the real need for resources is persistent over time and it displays a network effect, then the headquarters may have to reduce resource allocation even though the current reported need has increased. And this is because when the current reported need increases, the expected future need will increase by even more due to the network effect. Although it is in the headquarter's best interest to allocate more resources both for now and for the future, it simply cannot do so because it strictly relies on the quota mentioned before to keep the managers' incentives at bay.
So as a tradeoff, the headquarters may have to reduce the current resource allocation in order to save for the future. For similar problems in industry where a conflict of interests arises, these results actually point to some simple takeaways. First, a committed pool of resources over time can effectively prevent the manager from exaggerating. And second, it's not always as crazy as it sounds for the headquarters to move against the tide, especially in industries where network effect prevails and the growth is exponential because saving some resources for today means pushing more resources into the future where actually even more resources are truly needed.
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We know that conflict of interest often arises between heads of firms and department managers, when they have different goals,” says Yi Chen. He and his co-authors pose the research question: how should headquarters might balance against potential misinformation from management? Their findings suggest that when firm leaders provide managers with a committed pool of resources for a designated period of time, managers are less likely to exaggerate need and resources can be better preserved for the future.