Optimal Team Composition: Diversity to Foster Mutual Monitoring

In this paper, we study optimal team design. In our model, a principal assigns either heterogeneous agents to a team (a diverse team) or homogenous agents to a team (a specialized team) to perform repeated team production. We assume that specialized teams exhibit a productive substitutability (e.g., interchangeable efforts with decreasing returns to total effort), while diverse teams exhibit a productive complementarity (e.g., cross-functional teams). Diverse teams have an inherent advantage in fostering implicit/relational incentives for working that team members can provide to each other through mutual monitoring. In contrast, specialization both complicates the provision of incentives for mutual monitoring (for short expected career horizons) and creates an opportunity for tacit collusion (for long expected horizons). We also study diversity in expected career horizons (e.g., age) and show that having diverse career horizons within the team combats collusion more efficiently than grouping agents with the same career horizon into each team. We use our results to develop empirical implications for team composition, pay-for-performance sensitivity, team culture, and team tenure.