Seminar Abstract

Thursday, August 07, 2008 • 3:30 PM • Medium Conference Room, SFI

Paul Seabright Department of Economics, Universite de Toulouse

Behavior Discussion Group - Empire Building in Business and Politics

Politicians and corporate managers frequently either undertake projects whose budgetary costs are disproportionate to the benefits they create for the voters or shareholders those decision-makers represent. When they are not the result of simple random mistakes, such wasteful projects (commonly described as "empire building") are often attributed to weak mechanisms of accountability, such as inadequate opportunities for principals to exercise oversight, or capture of the governance mechanism by special interests. This paper argues that wasteful spending may be a by-product of the accountability of politicians or corporate managers to their voters or shareholders, not a symptom of its weakness or absence. Specifically, we develop a model in which agents have to do two things: first, search diligently for projects and secondly, screen them to decide which ones to fund. Funding projects that are wasteful is a way for agents to signal their diligence, and principals who cannot observe project quality directly will rationally reward them for this provided the benefits of diligence exceed the costs of empire-building. We introduce mechanisms of value-for-money auditing and show how politicians and managers may publicly resist them while sometimes privately welcoming them; auditing may, however, weaken incentives for agents to exercise control of their own on project choices, since it now becomes less costly for them to signal diligence. We then extend the model to see whether analogous incentive problems could explain why these same agents might sometimes fail to undertake projects that are clearly beneficial for principals. We show that agents will avoid projects that are "divisive" in the sense that they yield aggregate benefits but impose costs on some minority of principals (even if principals are risk-neutral), because their revealed willingness to accept costs imposed on minorities signals a relative lack of resolve to search for better projects.

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