The Good, the Bad and the Ugly: Agent Behavior and Efficiency in Open and Closed Organizations

This paper develops a novel model of agent behavior in organizations in order to compare the efficiency of “open” versus “closed” organizations. Closed organizations “screen” potential agents before admitting them while open organizations do not. Both have the option to “sort” (audit) individual behavior after observing aggregate outcome. Each agent is intrinsically “good,” “bad” or “ugly,” but can behave as any of the three types. Screening allows the organization to deny entry to the worst agent types, while sorting allows the organization to penalize opportunistic misbehavior by the agents. We show that both organizations may sort in equilibrium. When the sorting cost per agent is constant or exhibits economies of scale, surprisingly, both organizations sort the same number of agents, which leads agents of the same type to behave uniformly across organizations. However, agent behavior across intrinsic types may or may not be uniform. Interestingly, there is no equilibrium in which all agent types behave as good. When all agent types behave as bad or all behave as ugly, and an equilibrium exists in both organizations, closed organizations are less efficient from the organization’s perspective than open ones. When all agent types behave as ugly, closed organizations are socially inefficient as well. If agent behavior is a mixture of types, then closed organizations can be efficient because they screen out some of the worst agent types in advance. When organizations can precommit to a sorting frequency, more equilibria exist; for instance, all agent types may behave as good.