IZA DP No. 7322: Groupthink: Collective Delusions in Organizations and Markets
published in: Review of Economic Studies, 2013, 80 (2), 429-462
This paper investigates collective denial and willful blindness in groups, organizations and markets. Agents with anticipatory preferences, linked through an interaction structure, choose how to interpret and recall public signals about future prospects. Wishful thinking (denial of bad news) is shown to be contagious when it is harmful to others, and self-limiting when it is beneficial. Similarly, with Kreps-Porteus preferences, willful blindness (information avoidance) spreads when it increases the risks borne by others. This general mechanism can generate multiple social cognitions of reality, and in hierarchies it implies that realism and delusion will trickle down from the leaders. The welfare analysis differentiates group morale from groupthink and identifies a fundamental tension in organizations' attitudes toward dissent. Contagious exuberance can also seize asset markets, generating investment frenzies and crashes.