Authority versus Loyalty: Social Incentives and Modes of Governance

Abstract

This paper examines the effects of social ties on governance. Social ties are per se neutral and merely act as incentive bridges that transmit incentives between individuals. Whether such transmission of incentives improves or undermines governance depends on the particular incentives transmitted. We demonstrate this through a delegated monitoring model where the supervisor is friends with the agent and cares about social recognition. Two basic modes of governance emerge, authority and loyalty, which differ in whether they encourage or discourage social ties. This dichotomy reconciles opposing views on the effect of social ties on governance, and provides new perspectives on family firms, gray directors, business networks, and organizational culture.