Personal Relations and their Effect on Behavior in an Organizational Setting: An Experimental Study

Personal Relations and their Effect on Behavior in
an Organizational Setting: An Experimental Study

December 2006
Jordi Brandts and Carles Solà
Abstract
We study how personal relations affect performance in organizations. In the experimental
game we use a manager has to assign different degrees of decision power to two employees.
These two employees then have to make distributive decisions which affect themselves and
the manager. Our focus is on the effects on managers’ assignment of decision power and on
employees’ distributive decisions of one of the employees and the manager knowing each
other personally. Our evidence shows that managers tend to favor employees that they
personally know and that these employees tend, more than other employees, to favor the
manager in their distributive decisions. However, this behavior does not affect the
performance of the employees that do not know the manager. All these effects are
independent of whether the employees that know the manager are more or less productive
than those who do not know the manager. The results shed light on discrimination and
nepotism and its consequences for the performance of family firms and other organizations.

Keywords
Family firms, nepotism, corporate governance, procedural fairness, experiments
JEL Classification Codes: C92, D23, M50
Acknowledgements
Financial support from Spanish Ministerio de Educación, Ciencia y Deporte (SEJ2005-01690 and SEJ-2004-
07530-C04), the Barcelona Economics programme CREA, and the Catedra Banca March de l’Empresa
Familiar is greatfully acknowledged. The paper has benefitted from presentations at the ESA Asian regional
meeting in Hong-Kong and the ESA international meeting in Atlanta, both in 2006. The authors thank David
Rodríguez and Javier Valbuena for help in running the experiments.


Author addresses
Jordi Brandts
Carles Solà
Institut d’Anàlisi Econòmica (CSIC)
Universitat de les Illes Balears
Campus UAB
Campus UIB, Departament Economia de l’Empresa
08193 Bellaterra
07122 Palma
Spain
Spain

Phone +34-935806612
Phone: +34-971172438
Fax +34-935801452
Fax: +34-971172389
Jordi.Brandts@uab.es
carles.sola@uib.es

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1. Introduction
We present data from experiments in which we study whether people favor their
friends in a stylized organizational setting and whether this has any effect on the
behavior of other people involved in the situation. The principal motivation for our
study stems from the debate on discrimination and favoritism and the assignment of
responsibilities in family firms, but our work can also be related to other organizational
forms. Economists have recently been devoting considerable attention to the study of
family firms, a form of corporate governance which has a sizeable weight in most
economies (see La Porta, Lopez de Salinas, and Shleifer, 1999). In the work presented
here we use experiments to shed some light on some of the issues that up to now have
been studied using exclusively field data.
A number of previous field data studies focus directly on differences in
performance between family firms and non-family firms. Perhaps surprisingly the
empirical evidence is, at this point, mixed. Several papers support the transaction cost
hypothesis (Pollak, 1985) of no difference in performance, for example Cho (1998), or
Demsetz and Villalonga (2001). However, there is also evidence of both more
(Villalonga and Amit, 2004 and Morck, Shleifer and Vishny, 1998), and of less
economic value being created under family firm governance (McConaughy et al., 1998
and Anderson and Reeb, 2003).
Other studies aim at identifying more specific differences between family and
non-family firms. One of these differences pertains to issues of equity, distributive
justice and procedural justice. Greenberg (1990) surveys research on how different
justice notions interact with interpersonal effects. Van der Hayden et al. (2005) analyze
these ideas in the specific context of family firms, where personal relations play a key
role in certain decisions, and refer to the different concepts of distributive justice that

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play a key role in family firms. Families use need-based justice among its members,
managers use meritocracy and shareholders use equality. Distributive justice, hence,
may be difficult to implement in family firms due to the different criteria used between
agents.
From a different perspective, Schulze et al. (2001), Burkart et al. (2003), or
Mork et al. (2004) study how the agency problem (Jensen & Meckling, 1976) is
modified in family firms. A common theme of these studies is the altruism of the owner
towards the heir and the possible effects that this attitude may have in alleviating or
worsening the agency problems. This has been analyzed from a theoretical point of view
by Chami (2001) and Burkart et al. (2003). Nepotism, defined as favoritism shown or
patronage granted to relatives, is one possible consequence of this altruism. Similar
problems may arise in relation to personal friends.
The consequences of nepotism are somewhat controversial. Fama and Jensen
(1983) consider that family relationships between owners and managers reduce the
agency problem. Kang (2000) argues that family-related managers have a deep
knowledge of the firm that allows them to evaluate risks more adequately and to make
better strategic decisions. Miller and Le Breton-Miller (2006) discuss the possible
positive effects of choosing a family member as a top executive due to higher
motivation – in the line of stewardship theory.
Other analysts provide arguments and evidence in favor of the effects of
nepotism in family firms being negative. Pérez-Gonzalez (forthcoming) analyzes CEO
successions in family firms using data from 335 management transitions in publicly
traded U.S. corporations with concentrated ownership of founding family involvement.
He finds that promotion of CEOs with family ties is indeed frequent. Family CEOs
attain this position earlier than non family CEOs – on average eight years earlier. This

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kind of pro-family bias leads to considerable declines in performance, as measured by
returns on assets and market-to-book ratios. Moreover, this effect is greater when the
family CEO has not attended a selected business school (a signal of good quality);
interestingly, this school quality effect is not observed in non-family CEO promotions.
In the same line Kets de Vries (1993) points to the tolerance of inept family members as
managers. Schulze et al. (2001) indicate that nepotism may also affect other decisions
besides CEO succession: promotion to selected places in the organization, better
remunerations or more training. Kole (1997) and Bates, Jandik and Lehn (1998) find
evidence of theses practices.
We will refer to this bias based on family or personal relations that may result in
the choice of suboptimal managers and to the possible reactions of favored individuals
as the direct effects of nepotism. However, this may not be all that needs to be
considered. Nepotism may also have an indirect effect. If a decision based on family
relations or friendship violates economic or fairness principles, other agents in the
organization may feel discriminated since they do not benefit from the decision only
because they do not belong to the insider group. Hence, they may perceive that their
earnings, positions, status or job security levels are below what they deserve in
comparison to the insiders. If this perception arises, negative reactions from these
agents may result. This indirect effect in family firms is discussed in Schulze et al
(2001) and Gomez-Mejia et al. (2001).
Schulze et al. (2001) argue that agency threats of family ownership come
partially from adverse selection and hold up in non-family top management (also see
Kets de Vries, 1993). Gomez-Mejia et al. (2001) claim that these effects may go beyond
top management to middle management, and may generate shirking behavior. They
consider that “lower-level managers may resent the implicit immunity top-level

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executives gain from their family status rather than from demonstrated performance”
(Gomez-Mejia et al., 2001). Hence, the conflict between meritocracy and nepotism may
produce unsatisfied workers, who are less motivated to work hard. Miller and Le
Breton-Miller (2006) point out that a bias in favor of family candidates risks alienating
other talented managers.
In this paper we use a simple experimental design to study if, in the presence of
personal relations between agents, discrimination occurs and whether it leads to poor
results. The essence of what goes on in the organizational settings we are interested in
can be captured in a situation in which a decision-maker or manager has to assign
certain unequal degrees of responsibility or decision power to two different subordinates
or employees; one of the employees will obtain discretionary power over a larger part of
a pie than the other. These two employees then have to make distributive decisions
which affect themselves and the manager.
We study the impact of two treatment variables. The first is the existence of a
personal connection between the manager and one of the employees; we compare the
cases where this connection exists and where it does not exist. The other treatment
variable is the ratio of productivities of the two employees. In the base case the two
employees have the same productivity, whereas in the two other cases we look at the
productivities are different. The resulting design with six treatments makes it possible to
study the effect of a personal connection between the manager and one of the employees
for the cases where the employee in question is equally, more or less productive than
the other employee.
There are a good number of experiments on organizational behavior issues,
reflecting the fact that many interesting issues in the area can be nicely studied in the
kinds of stylized environments commonly used in experimental work. Some recent

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experimental studies in the area are those of Weber et al. (2001) and Malhotra and
Murnighan (2002) and Malhotra (2004). One of the things this kind of work has in
common with ours is that it studies interrelations between the effects of given material
(extrinsic) incentives and other motivational influences.
Our research is also related to the literature on social preferences. We will be
studying an environment in which a person will make a transfer to other persons hoping
to get something back. The fact that the other players often do return something can be
explained by notions of reciprocity (Sugden, 1984), fairness (Rabin, 1993) or inequality
aversion (Bolton and Ockenfels, 2000 and Fehr and Schmidt, 1999). These models and
the experiments directly related to them did not take into account the fact that many
interactions take place between people that know each other personally. However, there
are some experimental papers which do take into account interpersonal effects like the
ones we study here. An important general notion in this context is ‘social distance’ as
discussed in Akerloff (1997) and Hoffman et al. (1996). Bohnet and Frey (1999) show
that dictator game giving is affected by whether the dictator can simply visually identify
the recipient and by whether the recipient can identify the dictator. This is consistent
with the notion that letting subjects see each other, identify each other by names, etc.
reduces social distance For our purposes we needed preexistent social relations, a
situation with even less social distance.
Our treatment configuration makes it possible to study both the direct and indirect
effects of nepotism. In designing the experiment we have aimed at finding an unbiased
environment, which a priori does not seem to be specially favorable neither to the
existence nor the absence of the two effects of nepotism. Our objective was to let the
data speak for themselves.

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We find evidence for the direct nepotism effect in that managers tend to favor
employees that they personally know and that these employees tend, more than other
employees, to favor the manager in their distributive decisions. However, nepotism does
not affect the performance of the employees that do not know the manager. All these
effects are independent of whether the employees that know the manager are more or
less productive than the employees who do not know the manager. We also find that the
joint performance of employees is significantly higher in the presence of personal
relations, regardless of productivity differences.
2. Design and Hypotheses
In our game Player A is given a fixed amount of 10€ that has to be passed on to
Player B and Player C in fixed proportions. The choice that A has is to give 6€ to B and
4€ to C or vice versa.1 Player A can be seen as representing the manager of a firm or
organization who has to assign different levels of responsibility or decision power –
represented by the different shares of the initial pie - to two of her employees, B and C.
Once Player A has decided how to assign the two shares, the amount sent to player
B is multiplied by a factor MB and the amount received by player C is multiplied by MC.
These factors represent the productivities of the two agents or employees. The
introduction of these factors allows us to distinguish between responsibility and
productivity levels. While the shares the employees are assigned by the manager can be
seen as the responsibility levels, the multiplicative factors can be naturally interpreted as
the productivities of the two employees. This distinction is important for our analysis
below.

1 The game we use is similar to the game of Brandts et al. (2006) and is also related to the well-known trust game (Berg et. al.,
1995). This kind of games have been used to represent organizational environments like the one we study here.


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Our design incorporates two treatment variables. The first of them pertains to
whether the principal personally knows one of the agents or not. In our anonymous
treatments the game was played in the standard fashion: subjects did not know who the
others in the trio were. In our friends treatments Player A and Player B knew each other
personally, but both did not know Player C personally. In turn, Player C did not know
either Player A or Player B, but did know that Players A and B knew each other
personally.2
Apart from varying whether A and B know each other or not, we also vary the
factors MB and MC. We study 3 different productivity pairs. The first is the case of equal
productivities, MB=MC=3. The pies that – after the multiplication - the two employees
have to distribute will be of sizes 18€ and 12€. In the second configuration of
productivities, player B is a low productivity employee (hereafter we will refer to this
case as B Low) and the two productivities are MB=2.5 and MC=3.75. In the third case B
is a high productivity agent (hereafter, B High): MB=3.5 and MC=2.25.3
The numbers for the B Low and B High cases were selected in a way that keeps
the total pie size equal to the one in the baseline case of equal productivities at 30€ for
the case in which B obtains the larger share.4 Given this restriction B and C players can
not simply exchange the productivities between the two unequal productivities
treatments. The chosen productivities satisfy the restriction given by the baseline; in
addition we tried to keep the ratio of productivities as close as possible to the ratio of
shares. The ration of shares is 1.5, since (High Share)/(Low share)=6/4, while the ratio
of productivities is MB/MC=3.5/2.25=1.55 for the B High case, and
MC/MB=3.75/2.25=1.5 for the B Low case. However, remember that the comparisons

2 We did not try to control for the degree of personal relation or friendship. Our interest is in nepotism in the wider sense.
3 The appendix contains the instructions for the case where player B has the low productivity level, i.e. MB=2.5 and MC=3.75.

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that we are mainly interested in are the ones corresponding to the friends vs. anonymous
distinction, so that the above choice of parameters is not crucial.
Once players B and C have been informed about the amount received they have to
decide simultaneously and without any communication how much of the pie they
control they want to give (back) to Player A; we call these amounts xB and xC. The
payoff for player A is the sum of the amount sent by players B and C. Players B and C
get, respectively, what they decide to keep for themselves. The straightforward game
theoretical prediction in this game - if players’ utility functions just incorporate their
own payoff, the game is played only once and players do not know each other - is that
both Player B and Player C will give nothing to Player A. Player A is, hence, indifferent
with respect to how to distribute the initial pie between Player B and Player C.
Table 1 presents a summary of our treatments. In total we have six different cases
which arise from the three different productivity configurations of Player B and C and
the existence or absence of personal relations between player A and Player B. Table 1
also introduces the acronyms for the different treatments which we will use below.
Table 1. Summary of Treatments

PRODUCTIVITIES
B Low
Equal Prod.
B High
M
M
B<MC
B=MC
MB>MC
PERSONAL RELATION
A and B Friends
FEQP FBLOW
FBHIGH
Anonymous AEQP
ABLOW
ABHIGH

Our simple set-up makes it easy to focus on the precise issues that we want to
study. We can separately analyze the behavior of players A, B and C and we can study

4 2.5*6+3.75*4=30 and 3.5*6+2.25*4=30

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the impact of productivities on behavior. First, we are able to study how player A’s
assignment decision is influenced by whether she personally knows player B.
Second, we can study how player B’s decision is influenced by whether he has
been chosen by an A that knows him. In studying players A and B in the friends
treatment one has to take into account precisely that they know each other, so that, one
could say, that the experimental interaction will continue after the experiment itself. In
particular, the two friends may be able to share payoffs once the experiment is over. We
will get back to this when discussing the results.
Third, we can study the reaction of the C player to the existence of a personal
connection between A and B. For all three cases we will be able to see how the
influence of personal relations is affected by the productivity differences between B and
C. Note that the behavior of players A and B pertain to the direct effects of nepotism,
whereas it is in C’s behavior where we may find indirect effects of nepotism.
2. 1 The Direct Effects of Nepotism
The first issue is whether A players will tend to give the larger share of the pie to
Bs that are friends. This tendency is what we refer to as nepotism. Altruism has been
argued to be one of the main motives behind the direct effect of nepotism (Chami,
1999). Most people care more about family members or friends than for others and try
to help them in the organization. Of course, nepotism may also be influenced by the
strategic element of expecting to get more back from a friend than from a stranger. Both
forces can go together since it is possible that the altruism is mutual.
Note, however, that it is not obvious what to expect. A could suspect that a C
who is favored vis-à-vis a B friend could be especially generous. In addition, the
decision could be affected by the difference in productivities. When the friend is the
more productive of the two employees simple nepotism should bias the A player even

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