The Efficiency of Equity in Organizational Decision Processes

It is now widely accepted that rent-seeking (Anne Krueger, 1974) or directly unproductive profit seeking (Jagdish Bhagwati, 1982) may cause inefficiencies in the context of public sector decisions. The possibility that government decisions (for example, about taxes, quotas, franchises, or standards) may create or redistribute rents induces private parties to spend valuable resources to influence that distribution, even when such expenditures carry no social benefit. Moreover, the social cost of rent seeking can exceed the value of the resources spent trying to gain and protect rents, for example, because the fear of losing wealth through redistribution reduces the incentives for wealth creation. Treating rent-seeking activities as characteristic of public sector decision processes ignores the fact that similar phenomena are to be found in firms, unions, and other private sector organizations. Our recent work (Milgrom, 1988; our 1988, 1990 papers) attempts to identify the advantages of decision processes (private or public) that permit rent seeking, and to incorporate these into a cost-benefit analysis of optimal decision processes. Our work begins with an analysis of why rents and quasi rents arise in organizations and of the forms that the rent seeking they engender may take. Some measures to insulate the decision process from rent seeking, such as limits on the provision of information by interested parties or restrictions on the range of options considered, may degrade the quality of decisions, especially by blocking the flow of valuable information. Optimal decision processes balance the costs of rent seeking against the value of information obtained. Several aspects of the rules affect the opportunities that members have to spend resources trying to alter the distribution of rents. To ascertain the possibilities for rent seeking, the analyst must ask questions like: Can the parties propose new initiatives at any time? Can they give volumes of testimony in a form of their own choosing? Can they appeal adverse decisions? Are decision makers obliged to respond to the parties' initiatives? Is the range of actions that they can take in response relatively broad, rather than being tightly constrained by property rights or other formal rules? More affirmative answers to these questions lead to more opportunities or greater incentives for costly rent seeking. As a kind of shorthand, we call decision processes that have more of these elements "more open" processes. The very elements that make a process open to rent seeking may also add flexibility and responsiveness, helping to ensure that important ideas and proposals are fully considered. From this perspective, the benefits of openness can (in principle) be measured by a " value of information" calculation, in the usual manner of statistical decision theory. Weighing the costs and benefits, it follows that a more open process is more desirable when the rents available for redistribution are low, and the value of the information that might be acquired is high. Conversely, when the potential for redistribution is high and the value of information is low, the optimal decision process is less open. This kind of reasoning helps to illuminate the variations in the decision processes that are found in many organizations. We have discussed a number of examples in our earlier work, including the characteristics of personnel departments, the contrasting patterns of decision making, employment and compensation in U.S. and Japanese firms, *Professor of Economics, Stanford University, and Jonathan B. Lovelace Professor of Economics, Graduate School of Business, Stanford University, Stanford, CA 94305, respectively. This work was supported by the National Science Foundation.