"Corporations are people" said Mitt Romney. He was more right than he knew, because two new NBER papers by Christopher Parsons and colleagues show that companies are like people, in the sense that they are prone to peer effects:
We find that a firm's tendency to engage in financial misconduct increases with the misconduct rates of neighboring firms. This appears to be caused by peer effects, rather than exogenous shocks like regional variation in enforcement. Effects are stronger among firms of comparable size, and among CEOs of similar age.
In this sense, firms are just like ordinary people in that they are more likely to commit crimes if their peers do. This might be one reason why so many banks were involved in fixing Libor and in mis-selling PPI.
We find that a firm's investment is highly sensitive to the investments of other firms headquartered nearby, even those in very different industries...
We, of course, cannot rule out the possibility that area co-movements arise because of irrational herding, which would be the case if managers put too much weight on the beliefs of their neighbors.
There is, I suspect, an important political point here. There's a tendency to defer to "business leaders" as if they have superior insight into the economy; how often are they uncritically interviewed on the Today programme, for example? Such deference is misplaced. Rosewell and Ormerod have shown that "bosses have very limited capacities to acquire knowledge about the true impact of their strategies." And Charles Lee and Salman Arif have shown that higher capital spending leads to disappointing profits, consistent with it being driven by sentiment rather than a rational assessment of profitable projects. We should read Parsons' research in this tradition. It suggests that corporate bosses are not wise and rational leaders but are instead as easily led as impressionable teenagers.
So, why are we paying them so much?