Nepotism, Discrimination, and the Persistence of Utility-Maximizing, Owner-Operated

Firms: Reply
Author(s): Larry D. Singell and James Thornton
Source: Southern Economic Journal , Apr., 1999, Vol. 65, No. 4 (Apr., 1999), pp. 959-963
Published by: Southern Economic Association

Stable URL: https://www.jstor.org/stable/1061288

REFERENCES
Linked references are available on JSTOR for this article:
https://www.jstor.org/stable/1061288?seq=1&cid=pdf-
reference#references_tab_contents
You may need to log in to JSTOR to access the linked references.

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide
range of content in a trusted digital archive. We use information technology and tools to increase productivity and
facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at
https://about.jstor.org/terms

Southern Economic Association is collaborating with JSTOR to digitize, preserve and extend
access to Southern Economic Journal

This content downloaded from

182.255.0.242 on Sat, 25 Nov 2023 16:52:30 +00:00
All use subject to https://about.jstor.org/terms
Southern Economic Journal 1999, 65(4), 959-963

Nepotism, Discrimination, and the Persistence of Utility-

Maximizing, Owner-Operated Firms: Reply

Larry D. Singell* and James Thorntont

1. Introduction

In the comment on our paper (Sharir 1999), the author offers three criticisms of our
oretical model (Singell and Thornton 1997). First, we adopt a special case of a more gener
framework where proprietors may derive utility not only from nepotism and discriminatio
can arise from the owners' ability to choose who they employ but also from other activ
associated with owning and operating a firm, such as being the boss and making hiring deci
per se. Second, we assert mathematically, but do not argue convincingly, that proprietors d
utility from not interacting with workers who possess an attribute that is disliked (D-type
ers) rather than experiencing disutility from interacting with these types of workers. Thir
violate an adding-up constraint by asserting that the proportion of D-type workers and N
workers (workers whose interactions the employer likes) hired by biased proprietors wil
different from their population proportion. We discuss each of these criticisms below.

2. Simplifying Assumptions

The author asserts that our assumptions regarding how discrimination and nepotism e
into the preferences of an owner-operator render our model a special case of a more gen
framework. This is correct. A common and somewhat less restrictive assumption found in
literature on owner-operated firms is that the proprietor derives utility from one or more
pecuniary goods. A nonpecuniary good is taken to be any source of utility that must be obt
within the firm, presumably because markets do not exist for these sources of utility. To
eralize the arguments, the particular type of nonpecuniary good or goods that enter the an
is not specified, but a number of examples have been offered. These include being one's
boss, attractive but incompetent office workers, posh offices, and discrimination in employ
decisions (Olsen 1973; Feinberg 1975). In general, this literature demonstrates that utility-m
imizing firms behave differently from their profit-maximizing counterparts; in particular, se
papers show that these firms can survive when observable profits are negative because t
owners derive utility from a nonpecuniary good that must be obtained within the firm. T
proprietors are, in effect, producing a good that cannot be purchased in the market and p
for this good with residual income from their businesses.

* Department of Economics, University of Oregon, Eugene, OR 97403, USA; E-mail lsingell@oregon.uoregon.

corresponding author.
t Department of Economics, Eastern Michigan University, Ypsilanti, MI 48197, USA; E-mail
eco-thornton @ online.emich.edu.

959

This content downloaded from

182.255.0.242 on Sat, 25 Nov 2023 16:52:30 +00:00
All use subject to https://about.jstor.org/terms
960 Larry D. Singell and James Thorton

In our model, we make the simplifying assumption that only proprietors who have biased
preferences (e.g., race, ethnicity, gender) derive utility from choosing with whom they work.
We abstract from other possible firm-specific sources of utility, of which there are potentially
a large number, to focus our argument and emphasize that discrimination and nepotism can
generate the conditions in which the proprietor derives utility from owning and operating a
firm. We then show that proprietors with biased preferences will not maximize observable profit
but will willingly exchange some of the return on their investment in the firm for consumption
of discrimination and/or nepotism, which can only be obtained within the firm as part of the
production process. Our model highlights that discrimination and nepotism can persist over time
because, unlike in the traditional discrimination literature, the act of choosing who is employed
increases the welfare of proprietors who have biased preferences. This type of behavior can
persist in the long run as long as accounting profits are positive so that the resources of the
firm are not depleted through the purchases of the nonmarket good.
In addition, the author argues that, because we make a simplifying assumption that reduces
our model to a special case of a more general framework, our conclusions are not valid. In
particular, he asserts that our conclusions must change with less restrictive assumptions that
allow the proprietor to derive utility from other activities associated with owning and operating
a firm; however, he does not provide a formal demonstration of exactly how our results will
change.
In general, comments of this nature are somewhat unfair. Every model is dependent on
simplifying assumptions, which facilitate the process of logical deduction and in essence reduce
it to a special case of some more general model with an additional degree of complexity. We
believe that we have adopted the appropriate level of simplification to analyze the essential
features of the behavior of proprietors with biased preferences and address the question of
whether they can persist in the market. Suppose, for example, that we further complicate our
model by allowing all proprietors to derive utility from being the boss but we retain the as-
sumption that those who have biased preferences derive an additional nonpecuniary benefit from
the ability to interact or not interact with persons of their choosing. While the results of this
model depend on the relative importance placed on the various sources of utility from owning
and operating a firm, the behavior of biased and unbiased proprietors would likely differ in the
direction predicted by our simpler model. Thus, on one hand, it would not be surprising if the
predictions of a theoretical model change when its assumptions change. On the other hand, the
mere assertion by the author that the substantive conclusions of our model are necessarily
invalidated by broader assumptions, in the absence of a formal demonstration of this claim, is
unsubstantiated and cannot be taken as serious criticism.

3. Discrimination as a Nonmarket Good

The author expresses dissatisfaction with our assumption that proprietors derive utilit
avoiding interacting with workers who possess an attribute that is disliked. He pref
alternative assumption that proprietors experience disutility from interacting with wo
whom they have an aversion. In support of this preference, he claims to show that
interactions with disliked workers (i.e., discrimination) yields proprietors utility in ou
"simply due to a mathematical manipulation" and not because, in fact, it yields utility

This content downloaded from

182.255.0.242 on Sat, 25 Nov 2023 16:52:30 +00:00
All use subject to https://about.jstor.org/terms
 Notes and Comments 961

sympathetic to an ethical preference for not treating discrimination as a good, but

what puzzled by the author's mathematical argument.
From an analytical point of view, we believe it is equally plausible to assume t
etors get utility from avoiding disliked workers or disutility from interacting wit
viduals. On the surface, it appears that these two assumptions are equivalent stat
therefore which one is chosen should be a matter of analytical convenience. The
adopting the former assumption is that it allows us to treat discrimination as a non
which we believe is a useful way to think about the problem of discrimination for
explaining the behavior of proprietors with biased preferences. It is also consistent
tradition in economics of modeling goods, not bads, in the market basket. We sh
discrimination and nepotism cannot be publicly traded, then virtual prices can b
used to make the important distinction between accounting, observable, and econom
This facilitates clear thinking about the conditions under which discriminating
can compete and persist in a market with profit-maximizing firms. Moreover, b
missing market framework, which has found a number of other useful application
nomic literature (Bockstael and McConnell 1993; Comes 1993), we are able to deriv
implications about how discriminating proprietors respond to changes in input and
and, by doing so, believe we fill a void in the discrimination literature.
We are perplexed by the author's argument that discrimination yields propriet
in our model because of a mathematical manipulation, not because it actually yiel
our model, we define discrimination in terms of avoiding interactions with disli
We then assume that avoiding interactions with disliked workers yields utility t
with biased preferences and show that, based on this assumption, they are willin
discrimination with residual income from their business. This is similar to a traditional model

of labor supply behavior that defines leisure as time spent not working, assumes that time spent
not working yields utility, and shows that individuals are willing to pay for leisure with foregone
income (Killingsworth 1988). In the context of the labor supply model, one could argue that
time spent working actually yields disutility and purport to show that time spent not working
(leisure) yields utility simply due to a mathematical manipulation, not because it actually yields
utility. Once again, we believe that our starting assumptions, like the starting assumptions in
the traditional labor supply model, are useful for purposes of addressing the question of persis-
tence and deriving testable implications.
Whether proprietors with biased preferences actually derive utility from avoiding interac-
tions with disliked workers, or actually experience disutility from interacting with disliked
workers, seems to us to be a philosophical question that is not amenable to mathematical proof.
However, whether discrimination is modeled as a good or a bad can affect the predictions of
the model. For example, Goldberg (1982) adopts the Arrow model (Arrow 1973) but includes
a good associated with race rather than a bad. He replicates all the results of the Arrow model
except for the prediction regarding persistence. In particular, he shows that nepotistic behavior
not only can persist in the long run but may even be robust.

4. Adding-Up Restriction

The author argues that our model violates an adding-up restriction that is required for
internal consistency. In particular, we parameterize our model in such a way that all discrimi-

This content downloaded from

182.255.0.242 on Sat, 25 Nov 2023 16:52:30 +00:00
All use subject to https://about.jstor.org/terms
962 Larry D. Singell and James Thorton

nating proprietors desire to hire and interact with fewer D-type workers than their population
proportion and all nepotistic proprietors desire to hire and interact with more N-type workers
than their population proportion. However, our model does not include an adding-up restriction
that captures the collective behavior of all firms in the market. For example, suppose that each
utility-maximizing proprietor has biased preferences and therefore desires to hire fewer D-type
workers and more N-type workers than their population proportion at the current market wages.
Collectively, this would create an excess supply of D-type workers and/or an excess demand
for N-type workers. The author correctly points out that such a situation cannot persist in a
competitive labor market.
The possible inconsistency between the atomistic desires of individual proprietors and the
collective outcome of the labor market is a problem with most taste-based models of discrim-
ination. For example, the seminal paper by Arrow (1973) provides a formal representation of
Becker's taste for discrimination hypothesis. Arrow shows that in market equilibrium, the black-
white wage differential equals the difference in the marginal utility of white and black workers
divided by the marginal utility of profit. This condition resembles our equilibrium condition in
that it states what the market conditions must look like in order for the individual proprietor to
be maximizing utility. Thus, our model presumes the existence of a market in equilibrium, and
our population proportion results apply strictly for the marginal proprietor.
The mix of employee types for the inframarginal proprietor may well differ from that
which is specified in our paper. For example, suppose that a proprietor has a small relative bias
against D-type workers as compared to the market. In this case, the equilibrium wage differential
may more than compensate the proprietor for foregoing the consumption of discrimination,
thereby providing the financial incentive to produce and consume a negative amount of dis-
crimination in return for increased residual income from the business. Thus, as the author points
out, our framework does not limit the sign of the quantity of the nonmarket goods; in essence,
a negative value indicates that a proprietor willingly sells off his or her right to discrimination
or nepotism in exchange for residual income that can be used to purchase market goods.
To conclude, while the author correctly points out that some inframarginal proprietors may
not hire less than the population proportion of D-type workers or more than the population
proportion of N-type workers, this does not necessarily invalidate our results, because the "bi-
ased" composition of the workforce will hold for the marginal proprietor.

5. Conclusions

We believe that our approach of using a missing markets framework to analyze the b
of proprietors with biased preferences and to address the question of whether they can
in the market has much to offer. It is a useful way to think about the problem of em
nepotism and discrimination and is capable of generating testable implications. We also
that our assumptions are tenable and that our simplified model does not seriously dis
phenomenon that we are addressing.

References

Arrow, Kenneth. 1973. The theory of discrimination. In Discrimination in labor markets, edited by Orley Ashenfelte
and Albert Rees. Princeton, NJ: Princeton University Press, pp. 3-33.

This content downloaded from

182.255.0.242 on Sat, 25 Nov 2023 16:52:30 +00:00
All use subject to https://about.jstor.org/terms
 Notes and Comments 963

Bockstael, Nancy E., and Kenneth E. McConnell. 1993. Public goods as characteristics of non-market com
Economic Journal 103:1244-57.
Comes, Richard. 1993. Points rationing: Applications and analysis. Unpublished paper, Australian National Universit
Feinberg, Robert. 1975. Profit maximization versus utility maximization. Southern Economic Journal 42:130-1.
Goldberg, Matthew. 1982. Discrimination, nepotism, and long-run wage differentials. Quarterly Journal of Econom
97:307-19.

Killingsworth, Mark. 1988. Labor supply. Cambridge, MA: Cambridge University Press.
Olsen, E. Odgers. 1973. Utility maximization by an owner-manager. Southern Economic Journal 39:389-95.
Sharir, Shmuel. 1999. Nepotism, discrimination, and the persistence of utility-maximizing, owner-operated firms: A
ment. Southern Economic Journal 65:953-8.

Singell, Larry, and James Thorton. 1997. Nepotism, discrimination, and the persistence of utility-maximizing, owner-
operated firms. Southern Economic Journal 63:904-19.

This content downloaded from

182.255.0.242 on Sat, 25 Nov 2023 16:52:30 +00:00
All use subject to https://about.jstor.org/terms