Qiang Fu, Ming Li, and Xue Qiao
We consider a two-agent hierarchical organization with a leader and a specialist in a reputation-signaling model. The specialist proposes an innovative but risky project to the leader, and decides whether to exert an effort to improve the value of the project, which benefits the organization. The leader decides whether to endorse the project or block it. The leader’s competence is her private information, and the market updates its belief about the leader’s type based on observation of her action (endorsing the project or blocking it) and its outcome. In equilibrium, the leader could behave excessively conservatively when she is subject to reputation concerns. We have two main findings. First, aside from its usual distortionary effects, the leader’s reputation concern has a beneficial effect by inducing the specialist to supply productive effort and improves the organization’s performance. Second, there exists a nonmonotonic relationship between the perceived competence of the leader and the performance of the organization. As a result, a paradox of mediocracy emerges: The organization may benefit from a seemingly mediocre leader, as a mediocre leader motivates the specialist to exert effort, which offsets the efficiency loss due to incorrect decisions.