Issue 1

Volume 25 JOURNAL OF ECONOMICS & MANAGEMENT STRATEGY
Spring 2016

Endogenous Group Formation in Contests: Unobservable Sharing Rules

Kyung Hwan Baik
We study contests in which players compete by expending irreversible effort to win a prize, the prize is awarded to one of the players, the winner shares the prize with other players in his group, if any, and each group's sharing rule is unobservable to the other groups and the singletons, if any, when the players expend their effort. The number of groups, their sizes, and the number of singletons are exogenous in the first model, whereas they are endogenous in the second model. We show that group formation occurs if the number of players is four or smaller, but does not occur otherwise. We examine the effect of endogenous group formation on total effort level and the profitability of endogenous group formation. In each of the two models, comparing the outcomes of the case of unobservable sharing rules with those of the case of observable sharing rules, we show that the two cases yield quite different outcomes.

Search Engine Optimization: What Drives Organic Traffic to Retail Sites?

Michael R. Baye, Babur De los Santos, and Matthijs R. Wildenbeest
The lion's share of retail traffic through search engines originates from organic (natural) rather than sponsored (paid) links. We use a dataset constructed from over 12,000 search terms and 2 million users to identify drivers of the organic clicks that the top 759 retailers received from search engines in August 2012. Our results are potentially important for search engine optimization (SEO). We find that a retailer's investments in factors such as the quality and brand awareness of its site increases organic clicks through both a direct and an indirect effect. The direct effect stems purely from consumer behavior: The higher the quality of an online retailer, the greater the number of consumers who click its link rather than a competitor in the list of organic results. The indirect effect stems from our finding that search engines tend to place higher quality sites in better positions, which results in additional clicks because consumers tend to click links in more favorable positions. We also find that consumers who are older, wealthier, conduct searches from work, use fewer words, or include a brand name product in their search are more likely to click a retailer's organic link following a product search. Finally, the quality of a retailer's site appears to be especially important in attracting organic traffic from individuals with higher incomes. The beneficial direct and indirect effects of an online retailer's brand equity on organic clicks, coupled with the spillover effects on traffic through other online and traditional channels, leads us to conclude that investments in the quality and brand awareness of a site should be included as part of an SEO strategy.

Consumer Search with Limited Product Evaluation

Lin Liu and Anthony Dukes
Consumers need not evaluate all available product information before making a purchase. This may arise because shopping environments prevent a full evaluation (e.g., online). We develop a model of simultaneous search in which consumers have limited ability in product evaluation in order to study the impact of search cost on prices, consumer surplus, and social welfare. If consumers are endowed with the ability to choose how much information to acquire from a searched product, they may choose limited product evaluation. We find that consumers may evaluate more firms, enjoy lower prices, and higher surplus despite this limited ability. This implies that prices can decrease and consumer surplus can increase in search costs. We then extend our setting to the case of multiproduct firms and find similar effects due to changes in within-firm search costs.

Peer Evaluation: Incentives and Coworker Relations

Joeri Sol
In many workplaces, coworkers have the best information about each other's efforts. This paper studies a principal who only observes the joint output by two limitedly liable agents, while agents receive signals about each other's effort levels. The principal attempts to exploit this information through peer evaluation; agents are asked to report their signal and may receive a bonus for being evaluated positively. Lying aversion ascertains that truthful evaluation is possible, while interpersonal relations between colleagues give an incentive to misreport. This paper shows that peer evaluation gives an incentive for effort, even when the evaluations are not truthful. The peer evaluation bonus is constrained by more intensive coworker relations. Still, the optimal contract always includes a peer evaluation bonus, sometimes complemented with a team bonus. Coworker relations have nonmonotonic effects on profits in the optimal contract.

The Provision of Relative Performance Feedback: An Analysis of Performance and Satisfaction

Ghazala Azmat and Nagore Iriberri
This paper studies the effect of providing relative performance feedback on individuals’ performance, under two incentive schemes. In a laboratory setup, agents perform a real-effort task. We show that relative performance feedback increases performance when performance is related to pay (piece-rate) but has no effect on performance when pay is independent of performance (flat-rate). These effects are independent of the agent's relative position. Subjects are also asked to rate their satisfaction during the experiment. We find that under flat-rate, feedback has no effect on agents’ satisfaction, while under piece-rate, feedback about relative position affects satisfaction.

Promotion Signals, Experience, and Education

Michael Bognanno and Eduardo Melero
This paper uses a nation-wide representative survey of employees to examine whether more informative job promotions carry larger wage increases. In job assignment models with asymmetric information, unexpected promotions send a signal to the external labor market to revise upward their assessment of a worker's ability. The employing firm must then increase wages to prevent the worker from being bid away. Less educated workers are assumed to come from a group with lower average ability. Their promotion is hypothesized to induce a larger positive update of the assessment of their ability than the promotion of more educated workers. Promotions of less experienced workers, with less known about their abilities, should also result in strong signaling effects. We obtain regression results consistent with our hypotheses, although the size and significance of the estimates hinge on the promotion definition. Inexperienced workers gain more from promotions that entail new managerial responsibilities, whereas less educated workers gain more from nonmanagerial promotions. This sensitivity to the definition of promotion suggests that promotions reveal information on different dimensions of ability for different types of workers.

Tiered Housing Allocation with Preannounced Rankings: An Experimental Analysis

Juan D. Carrillo and Saurabh Singhal
We study in the laboratory a variant of the house allocation with existing tenants problem where subjects are partitioned into tiers with hierarchical privileges, and they know their position in the priority queue before making their decision. We evaluate the performance of the modified versions of three well-known mechanisms: Top Trading Cycle (TTC), Gale-Shapley, and Random Serial Dictatorship (RSD) with Squatting Rights. For all three mechanisms, we find low rates of participation (around 40%), high rates of truth-telling conditional on participation (around 90%), high proportions of fair allocations (above 90%), and significant efficiency losses. We also observe differences across mechanisms: RSD is ranked highest in efficiency and TTC is ranked lowest in fairness. We then show that position in the queue has a positive and significant impact on participation whereas tier has little effect on behavior. Finally, the individual analysis reveals that the majority of subjects who do not play according to the theory still follow discernible patterns of participation and preference revelation.

Choosing the Quality of the Fit between Complementary Products

Maxim Sinitsyn
In this paper, I examine how firms should position their complementary products. I assume that there are two competing firms, each producing two complementary products. Each firm decides whether to employ strategies that enhance the quality of the fit (the degree of complementarity) between its pair of complementary products before competing in prices. The consumers have heterogeneous tastes for the four possible bundles. They are willing to pay a price premium in order to purchase a bundle from the same firm if this firm chose to make such bundle more attractive. I find that increasing the degree of complementarity between a firm's complementary products intensifies price competition and often leads to smaller profits. Only when complementarity-enhancing strategies significantly increase the demand for a firm's matching bundle, does the firm benefit from employing them. The highest profits for both firms are obtained when both firms do not employ complementarity-enhancing strategies. Deteriorating the quality of the fit between one's own and a rival's complementary products is never profitable.

Competing for Consumers with Self-Control Problems

Alexei Alexandrov
I examine strategic implications of competing for consumers with self-control problems. For investment goods, like health clubs, I find that the equilibrium sign-up (lump-sum) fees decrease when competition intensifies, similarly to prices in standard oligopoly models. However, the equilibrium attendance (per-unit) price increases due to firms' deteriorated ability to take advantage of consumers' self-control problems. Moreover, firms earn less profit due to consumers' self-control problems—the firms have a unilateral incentive to charge per-unit fees lower than the marginal cost; however, they cannot make up the lost margins by increasing the lump-sum fee, due to competition. I also show that for plausible parameter regions the market adjusts to consumers' self-control problem in such a way that firms play the standard equilibrium strategies that they would have engaged in with fully rational consumers, with identical market outcomes. Most of the results are qualitatively the same for leisure goods (for example, credit cards); however, some results are reversed: the per-unit fees are higher than marginal cost and decrease as competition intensifies.

Charity Ratings

Barış K. Yörük
How do charitable donors respond to the third-party ratings that signal the quality of charities? I investigate this question using a novel data set from Charity Navigator, which provides quality ratings for 5,400 charities. Because Charity Navigator prominently displays a charity's star rating which is assigned based on its overall rating, one can identify the causal impact of a one star increase in ratings on charitable contributions with a regression discontinuity framework that exploits the threshold values of the overall ratings. I find that in general, the third-party ratings have a minor and often insignificant impact on charitable contributions received by charities. However, for relatively small charities, a higher rating leads to an increase in charitable contributions received. In particular, for these charities, I find that a one star increase in ratings is associated with a 19.5% increase in the amount of charitable contributions received. This result is robust under alternative model specifications and highlights the role of the third-party ratings in not-for-profit markets.

Quotas, Productivity, and Prices: The Case of Anchovy Fishing

Gabriel Natividad
I exploit a 2009 reform that introduced individual fishing quotas (catch shares) for Peruvian anchovy—the largest fishery in the world—to assess the causal impact of production quotas on within-firm productivity and market prices. Unique features of the data allow me to create two alternative counterfactuals: (i) anchovy fishing operations in a region of the country that was mandated to implement quotas with a delay, and (ii) variation in quota allocations across ships. I find that quotas do not increase within-asset or within-firm productivity in quantities. Instead, a 200% increase in anchovy prices benefits extraction firms through higher revenues, consistent with two mechanisms enacted by individual fishing quotas: more orderly industry operations reducing excess supply and an increase in bargaining power of extraction firms with respect to fish-processing. Several market characteristics across geographies differentially affect market prices after the quota regime. Supplementary evidence on fewer operational infractions, higher product quality, and a lower banking delinquency observed during the quota regime suggests the existence of efficiency gains rather than purely rent transfers.

Strategic and Natural Risk in Entrepreneurship: An Experimental Study

John Morgan, Henrik Orzen, Martin Sefton and Dana Sisak
We report on the results of experiments where participants choose between entrepreneurship and an outside option. Entrepreneurs enter a market and then make investment decisions to capture value. Payoffs depend on both strategic risk (i.e., the investments of other entrepreneurs) and natural risk (i.e., luck). Absent natural risk, participants endogenously sort themselves into entrepreneurial and safe types, and returns from the two paths converge. Adding natural risk fundamentally changes these conclusions: Here we observe excessive entry and excessive investment so that entrepreneurs earn systematically less than the outside option. These payoff differences persist even after many repetitions of the task. With a risky outside option, entry further increases and about one-third of entrepreneurs adopt a passive strategy, investing little or nothing. Finally, we examine an environment where an individual must become an entrepreneur but chooses the stakes over which she will compete. Due to under-entry and under-investment in the high stakes setting, the returns gap grows to over 15 percentage points. A two-factor model incorporating loss aversion and love of winning can rationalize these returns patterns.