Transparency and Innovation in Organizations

Abstract: In each period of our two-period principal-agent model, the agent adopts either a new or known idea and exerts implementation effort. The output depends on both effort and the quality of the adopted idea. While exerting effort, the agent can acquire know-how that is partially wasted upon changing ideas between the two periods. The principal decides whether to make the organization transparent or opaque, i.e., whether interim performance measures are observable or not to both parties. We show that transparency facilitates innovation, but may reduce the final output if the project requires more effort rather than quality idea. Counterintuitively, transparency can reduce the expected final output even more if the acquired know-how becomes less idea-specific or if the interim performance measure becomes more precise.