Leadership Style and Incentives

Julio J. Rotemberg · Garth Saloner

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Corporate Finance and Governance Leadership and Management in Organizations Organizational Management and Leadership

Abstract

We study the relationship between a firm's environment and its optimal leadership style. We use a model in which contracts between the firm and managers are incomplete so that providing incentives to subordinates is not straightforward. Leadership style, whether based on organizational culture or on the personality of the leader, then affects the incentive contracts that can be offered to subordinates. We show that leaders who empathize with their employees adopt a participatory style and that shareholders gain from appointing such leaders when the firm has the potential for exploiting numerous innovative ideas. By contrast, when the environment is poor in new ideas, shareholders benefit from hiring a more selfish (i.e., more profit maximizing) leader whose style is more autocratic.

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1937The Nature of the Firm 1979Moral Hazard and Observability 1967Organization and environment 1972A measure of emotional empathy1 1990Corporate culture and economic theory 1988Incomplete Contracts and Renegotiation 1981The art of Japanese management 1989Corporations, Culture, and Commitment: Motivation and Social Control in Organizations

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