Functional vs. Cross-Functional Teams and the Role of Productive Heterogeneity

An emerging body of research on teams highlights the importance of implicit incentives for cooperation and/or collusion that rely on mutual monitoring among team members. Whereas prior research on mutual monitoring in team production settings typically assumes that agents have identical abilities, this paper examines how such incentives operate when team members differ in their productive abilities. We show that the role of productive heterogeneity depends on the nature of team production. In cross-functional teams, collusion does not arise, and productive heterogeneity does not alter the qualitative nature of cooperative incentives. In functional teams, heterogeneity introduces additional (binding) constraints that ensure that both more and less productive agents are motivated to cooperate. However, when collusion among team members is a concern, productive heterogeneity can be advantageous. The optimal means of preventing collusion in functional teams is to employ asymmetric contracts, where the more productive agent receives higher-powered collusion-proof incentives. Asymmetric contracts shift effort away from the more productive agent under potential collusion, which reduces the agents’ joint gains from collusion. Productive heterogeneity is advantageous in functional teams when there is a high degree of productive substitutability and/or a high discount factor. These conditions lead to a severe collusion problem, which is mitigated by productive heterogeneity. When the productive substitutability and/or the discount factor are low, the optimal productive heterogeneity is either small or none. We also study optimal team design, allowing the principal to choose between a functional team and a cross-functional team and the optimal level of productive heterogeneity. This paper was accepted by Ranjani Krishnan, accounting. Funding: E. Kim acknowledges financial support from a PSC-CUNY Award [Cycle 56], jointly funded by the Professional Staff Congress and The City University of New York.