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

Abstract

Much debate in the discrimination literature surrounds whether employers with biased preferences can persist in the market [7; 10]. This issue is a natural extension of the broader literature on owner-operated firms, which focuses on the consistency of utility and profit maximization [12; 13; 14; 18; 26; 27]. Theories of owner-operated firms, which have a long history in economics, model the entrepreneur as both a producer and consumer of goods that determines the level of production and consumption jointly through utility maximization [2; 9; 16; 22; 31]. This approach is applied in this paper to examine employer discrimination and nepotism. Our analysis provides necessary conditions for utility-maximizing firms to persist in the market and shows how biased preferences can yield seemingly uneconomic input and output choices that are in fact rationally inefficient. Empirical results, using data on family farms, support the prediction that utility-maximizing entrepreneurs trade profit for nonmarket goods and do not hire inputs to maximize profits. Competitive, neoclassical theories of the labor market do not provide a clear theoretical resolution to the issue of persistence of employer nepotism and discrimination. The employer discrimination model, proposed by Becker [4; 5] and extended by Arrow [1], postulates that entrepreneurs maximize utility that increases with profit but decreases with a nonmarket attribute of some workers (e.g., race, ethnicity, or gender). These models predict that white male workers may initially have better market opportunities than comparable minority or female workers. However, entrepreneurs who hire based on nonproductive attributes are also predicted to earn less than a normal rate of return and, because they derive disutility from an aspect of owning and operating a firm, can improve their welfare by leaving the industry and converting firm assets to those that do not require employment decisions (e.g., stocks and bonds). This result has the important policy implication that market intervention may not be necessary to improve the relative pay and employment of disadvantaged groups when employers are the source of the discrimination. Alternatively, Goldberg [15] uses the Arrow [1] framework but postulates that employers