We model experimentally the governance of an institution. The optimal management of this institution depends on the information possessed by insiders. However, insiders, whose interests are not aligned with the interests of the institution, may choose to use their information to further personal rather than institutional ends. Researchers (e.g., Palfrey 1990) and the business press have both argued that multiagent mechanisms, which inject trustworthy but uninformed “watchdog” agents into the governance process and impose penalties for conflicting recommendations, can implement institutionally preferred outcomes. Our laboratory experiments strongly support this conclusion. In the experimental treatments in which watchdog agents were included, the intuitionally preferred allocation was implemented in the vast majority of cases. Surprisingly, implementation occurred even in the absence of penalties for conflicting recommendations.
JEL classification: G3, C7
Key words: corporate governance, implementation, experimental economics, mechanism design
The authors thank participants of the Atlanta Finance Workshop and the Economic Science Association Meetings for useful comments. Gillette acknowledges research support from the College of Business Administration, Georgia State University. This paper was completed while Gillette was a visiting scholar at the Federal Reserve Bank of Atlanta. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.
Please address questions regarding content to Ann B. Gillette, Department of Finance, J. Mack Robinson College of Business, Georgia State University, University Plaza, Atlanta, Georgia 30303-3083, 404-651-2671, 404-651-2630 (fax), firstname.lastname@example.org; Thomas H. Noe, A.B. Freeman School of Business, Tulane University, New Orleans, Louisiana 70118-5669, 504-865-5425, email@example.com; or Michael J. Rebello, Department of Finance, J. Mack Robinson College of Business, Georgia State University, University Plaza, Atlanta, Georgia 30303-3083, 404-651-2781, firstname.lastname@example.org.
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