All sessions together Flashcards
TOF Approach
Identify the coordination and cooperation (incentives, motivation) problems in each alternative.
Use this to reason about what is the best alternative.
“Best” = alternative that creates most value for the involved parties.
What are some coordination problems?
Team work more difficult to execute; challenges of sequencing work; greater need for formalization, advance planning; difficult to read facial, body language; harder to explain tasks to new hires; etc.
Division of labor between parties not clear, insufficient pre-planning, no procedures for reacting to disturbances, lack of communication, non-overlapping beliefs/culture, etc. → omitting important activities, incompatible activities, resource allocation, break-up …
What are some cooperation problems?
Shirking may become an issue b/c of greater difficulties of monitoring remote work (but remote could also make individual efforts more transparent). Less peer pressure.
Shirking, hold-up, undesired knowledge leaks, poaching of key employees, lack of trust, etc. → frictions, low investments, break-up …
What is a firm ?
“A firm is characterized by the employment contract, in which an employee accepts to take unspecified future orders (within limits) from an employer against payment – i.e., AUTHORITY.” Coase [emphasis added].
Why does the firm exist?
Discovering relevant prices (coordination).
Negotiating and concluding a separate contract for each exchange (cooperation).
Coordinating when tasks are uncertain.
The firm may avoid many of these costs.
(Firm) Optimum size (boundaries):
where the costs of organizing a transaction inside the firm = cost of organizing it using the price mechanism (market).
Q1: From the perspective of the TOF, managers
- Shape cultures.
- Install the core beliefs of the organization in employees.
- Solve specific motivation and coordination problems in a way that is superior to what markets can do.
- Solve specific motivation and coordination problems in a way that is superior to what markets can do.
Q2: Coordination is about avoiding free-riding, poaching of key employees, and the lack of trust.
True
False
False
Q3: The Theory of the Firms suggests that the division of labor should be maximized.
True
False
False
Q4: Coase suggested that the optimum size of the firm is determined by
A. Economies of scale.
B. The size of the market
C. The tradeoff between internal costs of organization and transaction costs in the market.
The tradeoff between internal costs of organization and transaction costs in the market.
Q5: Coordination problems in firms are primarily solved by means of incentives.
A. True
B. False
False
Q7: “Making” rather than “buying” (from the market) makes sense when
A. There are no platforms.
B. Making is less costly overall than buying.
C. The organizational costs of making are less than market transaction costs.
D. A and B
E. B and C.
E. B and C.
Q8: Outsourcing is almost always the best option.
A. True
B. False
False
Q9: The Theory of the Firm is about
A. All firms and their relations to other firms (and various stakeholders).
B. Successful firms mainly.
C. Corporations mainly.
A. All firms and their relations to other firms (and various stakeholders).
Q10: The theory of the firm is also about contracts between firms.
A. True
B. False.
true
Definition of a strategy in Game Theory
A specification of an action/choice for
each possible history/contingency/
situation which might occur.
Definition of Nash equilibrium
A payoff maximising strategy for each player, given the choice of strategy of other players.
How to sustain cooperation
-Between firms?
-Inside firms?
Between firms
Contract law, legal system, mediators/arbitrators, reputations, repeated interaction … that enforce contracts.
Inside firms:
Between employees, employers: Employment law, mediators/arbitrators, unions/employers’ associations, reputation, culture, repeated interaction.
Between organizational units: Fiat/authority, culture, repeated interaction.
What is imperfect enforcement?
These mechanisms help, but don’t work perfectly.
Reputation mechanisms are not perfect (think TrustPilot or Tripadvisor).
The legal system may be imperfect (slow, over-burdened, etc.), based on unfamiliar legal doctrine, or even corrupt.
What exactly happened in the dispute? Court may be asymmetrically informed; make ”wrong” decision.
Costly to make use of enforcement mechanisms (think corporate lawyers).
Improving outcomes by changing
Players—e.g., get rid of bad suppliers.
Payoffs—e.g., incentivize players to not choose ”bad” strategies (e.g., pay your employees more than what the rivals pay).
Choices—e.g., job descriptions (e.g., multi-tasking may have advantages, but also drawbacks …).
Information—e.g., management information systems, financial control, activity-based costing, benchmarking …
Interaction—e.g., repeated interaction often better than one-shot interaction.
Bounded rationality
humans have inherent cognitive limitations
Heuristics help
intuition, heuristics, rule of thumbs, etc. are useful.
Biases
Decision-making errors.
Q1: Nash equilibrium requires that there are “many” players.
True
False
False
Q2: When asymmetric information is introduced into a game, this typically
1. Changes the strategy set.
2. Changes the outcomes of the game.
3. Both A) and B).
- Both A) and B).
Q3: Cognitive biases help us understand why CEOs
A. Make errors that are entirely specific to the firm.
B. Make systematic decision making errors.
C. Make random decision making errors.
B. Make systematic decision making errors.
Q4: In a game, the number of subgame perfect equilibria will always be higher than the number of Nash equilibria.
True
False
False
Q5: In classical decision theory, decision-makers have unstable, preferences, limited attentional and computational capacities, and their behaviors are driven by expectation of consequences.
True
False
False
Q6. Loss aversion means that
1. We pay more attention to non-recoverable costs (potential losses) when considering future actions.
2. We feel losses more acutely than gains of the same amount.
3. We root our thinking in an initial value and, fearing loss, we fail to sufficiently adjust our thinking away from that value.
- We feel losses more acutely than gains of the same amount.
Q7: Excessive optimism and overconfidence are examples of stability biases:
True
False
False
Q8: When we seek to find the subgame perfect equilibrium of a game, we
1. Start at the bottom of the extensive form game and solve by means of backward induction.
2. Start at the top of the extensive form game and solve by means of forward deduction.
3. Add players to the game.
- Start at the bottom of the extensive form game and solve by means of backward induction.
Q9: Cognitive biases are always problematic (i.e., reduce value creation) to firms.
True
False
False
Q10: In game theory, “strategies” are those actions of a player that are not conditioned on what other players do:
True
False
False
What is efficiency?
Efficiency as maximizing the sum of producers’ and consumers’ surpluses.
For instance, the monopoly quantity vs. market quantity. The competitive output maximizes welfare i.e., the sum of producers and consumers surplus—so producing Qpc is efficient.
When can efficiency be defined as value maximization?
When 1) the utility of players can be measured in money equivalents (as in a ”reservation price”),
and 2) utilities measured in this way can be summed over players (as in the ”consumers’ surplus”),
then 3) efficiency can be defined as value maximization.
When is doing X (investments, organizational structure, contracts, etc.) efficient?
If it contributes to maximizing the Σ money equivalents of utilities (”value max”).
Two situations where markets -> efficiency (i.e., no need for firms!) (“first-best” outcomes).
The Fundamental Welfare Theorem (textbook, chpt 3).
The Coase theorem (textbook, chpt 4).
What is the (1st) Welfare Theorem?
If
1. each firm maximizes its profits, knowing the prices and its own production technology;
2. each consumer maximizes utility, knowing the prices and his own preferences;
3. income and prices are such that demand equals supply for every good and service,
then the resulting allocation of goods and services is Pareto optimal.
Some limitations:
Large number of consumers and producers
Law of one price
Anonymity
Production function view of firm
Communication structure
Contracts (complete contingent)
Complete rationality
Decentralisation
Coordination
Complete set of markets
No externalities
All goods and services can be exchanged
… Etc.
The Coase Theorem: Externality
Externality: Result of an activity that causes benefits (costs) to others with no corresponding compensation provided to (or paid by) those who generate the externality.
Does the equilibrium change if property rights are involved?
No. Regardless of the allocation of property rights, the equilibrium is the same.
The Coase Theorem (transaction costs, wealth effects.. etc.)
If 1) transaction costs are zero, so that bargaining is costless, and 2) there are no wealth effects, then any allocation of property rights results in an efficient outcome.
(“if there are no transaction costs, no wealth effects, voluntary bargaining always lead to efficiency”)
“No wealth effects” means
choices can be expressed in money;
choices do not depend on wealth position;
there are no financial restrictions regarding establishing a deal.
Realistic assumption when the amount of money involved is small relative to the financial position of the decision maker.
Q1: The First Welfare Theorem says that any efficient allocation can be decentralized as a competitive equilibrium.
True
False
False
Q2: In the world described by the First Welfare Theorem, there are no cooperation problems but there may be coordination problems.
True
False
False
Q3: Cognitive biases may be a source of bargaining costs.
True
False.
True
Q4: The Coase Theorem assumes that
Transaction costs are zero
Transaction costs are zero and there are no wealth effects.
The sub-game perfect equilibrium will always be optimal.
Transaction costs are zero and there are no wealth effects.
Q5: The First Welfare Theorem and the Coase Theorem:
Describe realistic theoretical ideals.
Present imaginary worlds in which markets don’t exist.
Describe the conditions under which first best efficient outcomes can be reached.
Describe the conditions under which first best efficient outcomes can be reached.
Q6. A key implication of the Coase Theorem is that the more complete a contract, the further away we get from efficiency (all else equal):
True
False
False
Q7: The Coase Theorem implies that the closer we get to full information, the closer we get to efficiency (all else equal):
True
False
True
Q8: When transaction costs are really high, firms are highly flexible.
True
False
False
Q9: When there are transaction costs and wealth effects, efficiency has no meaning.
True
False
False
Q10: Firms cannot use the price mechanism inside their hierarchies, as prices only make sense in a market:
True
False
False
When does agency problems arise?
When you need to incentivize people who carry out a task for you, but you don’t know what they know and there is a latent conflict of interests.
Ingredients in the PA problem
- Surplus available / gains from trade, i.e. there are opportunities for value generating exchange.
- Conflict of interests (how much effort and risk -> agent)
- Asymmetric information (the agent has superior information compared to the principal)
In an agency relation, moral hazard results when:
1) The agent can engage in post-contractual behavior that affects the utility of both principal and agent (externality);
2) the principal can only observe an imperfect signal of the agent’s effort (usually the outcome – not the actual effort exerted!) (control problem); and
3) the action the agent will take spontaneously is not optimal (inefficiency).
How can moral hazard be reduced?
By incentivizing the agent
(Tradeoff between ”insuring” the agent and giving him incentives)
What does “insuring the agent mean?”
= removing risk from him = putting him on a flatter wage (less performance-dependent) (NB: Agent usually assumed to be «risk-averse»)
What does “giving the agent incentives” mean?
Making his pay more performance-dependent
Explain the trade-off between stronger and weaker incentives
«Tradeoff»:
Give the agent stronger incentives → he works harder but he faces more risk which he does not like (wants a risk-premium) (P is happier, A is less happy)
Give the agent weaker incentives → he works less hard but faces less risk (smaller risk-premium) (P is less happy, A is more happy)
Three strategies for handling the agency problem
Change the choice possibilities (i.e., job descriptions, tasks, what can be done with corporate resources) – “change the rules of the game”.
Engage in monitoring – “change the information in the game”.
Provide incentives – “change the payoffs in the game”.
Look more closely at incentive management and how it interacts with monitoring.
The agent’s wage (linear wage model)
W = W0 + B ( e + 0l )
The agent’s utility
U = U(W) – C(e)
The agent’s utility from remuneration U(W) is dependent on the (uncertain) result z (i.e., the agent’s wage is uncertain).
The agent’s certainty equivalent
CEA = “expected wage”– “risk premium for agent”–“cost”
The principal’s certainty equivalent
CEP = “exp. value” – “exp. wage for agent” – “risk premium”
What does the optimal contract between principal and agent do?
Maximizes the total value of the relationship
Incentive intensity:
the size of beta
Monitoring intensity:
the amount of resources needed to estimate e.
W = W_0 + beta ( e + x )
Examples for a high beta (incentive intensity?)
For
1. Fine when effort has a high incentive elasticity.
2. ”Self-selection”: Laggards, shirkers stay away!
3. Can foster upgrading of skills and knowledge.
Etc.
Examples against a high beta (incentive intensity?)
What is ”z”?
1. Heterogeneity in the measure.
2. Multi-tasking problem; e.g., reduction of helpfulness.
3. How to decide the ”normal” effort level (for which beta = 0)?
Q1: The basic ingredients of the agency problem are
A. Incomplete contracts, opportunism, and asset specificity.
B. A surplus, asymmetric information, and conflicts of interest.
C. A principal, an agent, and a conflict.
B. A surplus, asymmetric information, and conflicts of interest.
Q2: The agency problem describes a situation where the Coase Theorem doesn’t hold.
A. True
B. False
True
Q3: In agency theory, contracting is such that the parties can perfectly observe each other’s actions:
A. True
B. False.
B. False.
Q4: In agency theory monitoring and incentives are alternatives:
A. True
B. False
B. False
Q5: The efficient agency contract
A. Meets the participation constraint
B. Has zero wealth effects.
C. Meets the participation and the incentive constraints.
C. Meets the participation and the incentive constraints.
Q6. A high β in the wage equation should be adopted
A. When agents are low in risk aversion and their efforts are highly responsive to incentives.
B. When the signal on the agent’s effort (z) is very noisy.
C. When the relation between the production result and the agent’s efforts are rather ambigious and the agent engages in one or only a few tasks.
A. When agents are low in risk aversion and their efforts are highly responsive to incentives.
Q7: A low β in the wage equation means that the firm is more likely to recruit high performers:
A. True
B. False
B. False
Q8: Adopting a high-powered incentive system (high β) means that management need to care less about rewards:
A. True
B. False
B. False
Q9: The tradeoff between incentives and insurance can be influenced by, e.g., management info systems:
A. True
B. False
A. True
Q10: Firms that delegate more will have more agency problems:
A. True
B. False
A. True
Types of Incentive Pay
Gainsharing / group incentives:
Pay tied to gains in measures of group “success” (productivity, costs, quality, etc.).
E.g., tip pooling (waiters/tresses), casino dealers.
Profit-sharing: Pay tied to profits of firm.
E.g., Handelsbanken.
Efficiency wages: Paying employees a “premium.”
Piece rates:
Pay tied to amount of output produced.
E.g., sales commissions; garment workers.
Piece rates:
- Mention employee preferences
- Mention Employer preferences
Employee pref:
If the expected level of pay constant, employees may prefer time-based over piece rate.
Piece rate is “riskier”
Production process is uncertain.
Piece rate will cause self-selection on
Productivity
Risk aversion
Employer pref:
Advantages:
Productivity is increased among a given work force.
Attract most productive workers.
Disadvantages:
Quantity vs. Quality
Willingness to help coworkers
Treatment of equipment
Cost of monitoring output
Sales: who made the sale?
Is there a single “output” that can be measured?
Why are CEOs paid so (increasingly) well?
Conspiracies between well-connected aspiring CEOs to not underbid each other.
Imitation: Very high exec pay is a managerial practice that gives you credibility as a firm.
Skimming: CEOs are better able to manipulate their pay (e.g., in many stock option program, base pay wasn’t adjusted (downward))
Much greater risk of being dismissed
Mechanisms that handle agency problem
Board of directors (evaluate managers against high performance standards)
Shareholder activism (proxy battles, right to sue for damages if directors or managers fail to meet their obligations,
External forces: Market for corporate control, auditors, banks and analysts, regulatory bodies, legislation (e.g., SOX), media and public activists, etc.
Q1: An agent’s utility of W depends on var (W), even if E (W) stays constant.
A. True
B. False
A. True
Q2: Lazear’s analysis suggests that firms should in general adopt pay-for-performance:
True
False
False
Q3: Jensen & Murphy’s findings suggest that the agency problem in US corporate governance is very small:
True
False.
False.
Q4: In Lazear’s analysis of incentives in Safelite Glass, Var (output / employee) was reduced.
True
False
False
Q5: A low β in the wage equation makes sense when
Employees work independently.
Jobs involve a low level of multitasking.
Individual productivities are difficult to measure.
Individual productivities are difficult to measure.
Q6. In Safelite Glass, the increase in β led to less employee sorting in and out of the firm.
True
False.
True
Q7: According to Jensen & Murphy, the link between CEO pay and shareholder wealth is weak because
CEOs are risk-averse.
The public dislikes high CEO pay..
Boards are very good at (input-)monitoring CEOs so they don’t need to tie pay and firm performance together.
The public dislikes high CEO pay..
Q8: In agency theory, the contracting problem is that the principal fails to anticipate certain contingencies:
True
False (the P anticipates all possible contingencies but does not what exactly the agent did and the realization of the random variable).
False (the P anticipates all possible contingencies but does not what exactly the agent did and the realization of the random variable).
Q9: Inefficiency in a PA relation arises because
The parties face asymmetric information.
Because of the agent’s risk aversion.
Because it is not possible at the same time to make the agent pick the efficient action and efficiently share risk between P and A.
Because it is not possible at the same time to make the agent pick the efficient action and efficiently share risk between P and A.
Q10: In Jensen & Murphy’s analysis, relatively low executive pay is partly compensated by a high risk of dismissal:
True
False
False
Q11. In the agency problem, the risk premium
A. Is a cost that emerges because of different risk prefences and asymmetric information.
B. Compensates the agent for the loss in utility he suffers when Var (W) increases.
C. Varies positively with β
D. A and B.
E. B and C
F. A, B and C.
F. A, B and C.
Q12: Jensen & Murphy demonstrates that when the β faced by executives increases, this causes a gain to shareholders.
True
False
False
Q13: In agency theory, it is costless to write a contract:
True
False
True
Q14: Employees generally prefer piece rates because this pay arrangement increases their income:
True
False
False
Q15: Two employees handle 6 activities which consume the same amount of time and which differ in measurability. All else being equal, the activities should be allocated such that
A. Employee A handle those activities that are most easy to measure, while Employee B handles those activities that are most difficult to measure.
B. In this situation, the activity mix across the employees doesn’t matter.
C. Employee A handle one easy-to-measure, while Employee B handles two of these, and the difficult-to-measure activities are then allocated with two to and one to B.
D. The best approach is to randomize the allocation of activities for reasons of risk allocation.
A. Employee A handle those activities that are most easy to measure, while Employee B handles those activities that are most difficult to measure.
Q16. When there are no problems of misaligned incentives (moral hazard), all frictions that may impede exchange are absent, and then actors will immediately reach value-maximizing (“first best”) outcomes.
True
False
False
Q17: Jim Smith is a taxi driver in New York City. He works for the Big Yellow Taxi Company. On average he can generate $100 of net revenue (after fuel costs, etc.) by working in his cab for one hour (i.e., 100h, where h is any given number of hours). His personal cost of effort is 10h^2, where h is the hours worked in the cab during the day. Both Jim and the owners of the taxi company are risk neutral. Jim’s outside opportunities require that he be paid average compensation of at least $50/day plus his personal costs of effort.
The numbers of hours worked per day that maximize the expected surplus from hiring Jim are:
A. 8 hrs.
B. 5 hrs. Differentiate 100h-10h2 and set equal to 0; then h = 5).
C. 7 hrs.
B. 5 hrs. Differentiate 100h-10h2 and set equal to 0; then h = 5).
«Decision rights»
(aka «control», «property rights», «authority», «empowerment»).
Constrained rights
rights to use corporate resources; not rights to dispose of, sell, destroy, etc. such resources or use them for personal gain that is not related to the firm.
Centralized firm
Many hierarchical layers need to look at the idea (”fine-grained filter”)
Centralized firm good at rejecting projects—but will also reject more good projects.
Decentralized firm
Few hierarchical layers (”coarse-grained filter”).
Decentralized firm good at accepting projects—but will also accept more bad projects.
Why delegate?
- Opportunity cost of time
- Motivation
- Knowledge
Benefits & Costs of Delegation
Benefits
Economizing with managerial time
Speedy decision making
Motivation
Utilizing ”local” (tacit) knowledge
Costs
Agency costs
(Evaluation mistakes)
(Costs of coordinating interdependent activities in the face of change)
Activitity-based costing?
«Activity-based costing(ABC) is acostingmethod that identifies activities in an organization and assigns thecostof eachactivityto all products and services according to the actual consumption by each. This model assigns more indirectcosts(overhead) into directcostscompared to conventionalcosting.” (wiki)
Total quality management?
“A coredefinitionoftotal quality management(TQM) describes amanagementapproach to long-term success through customer satisfaction. In aTQMeffort, all members of an organization participate in improving processes, products, services, and the culture in which they work.” (asq.org). This involves defining multiple quality measures (time to delivery, average quality level, var (quality), etc. and breaking these down to teams and even individuals.
Lesson fra spaghetti organization
Radical delegation can revitalize an organization by mobilizing benefits of delegation—improved motivation, more creativity, better utilization of local knowledge.
However, also many coordination and cooperation problems.
Eventually, costs overwhelmed benefits, causing the change to a more structured matrix org.
Firms are not markets: Even highly decentralized firms are characterized by the use of authority (cf. Coase).
Delegated rights are ”loaned, not owned.”
Q1: Delegation is likely to lead to increases of β in the linear wage equation.
True
False
True
Q2: When information is symmetric, delegation increases the agency problem
True
False
False
Q3: Optimum delegation
1.Equalizes the total costs and benefits of delegation.
2.Equalizes the marginal costs and benefits of delegation.
3.Means that all local knowledge in the firm is exploited.
2.Equalizes the marginal costs and benefits of delegation.
Q4: The more specialized job functions are, the more delegation.
True
False
False
Q5: Firms in fast-moving industries are likely to have a higher level of delegation.
True
False
True
Q6. Delegation may itself reduce agency costs.
True
False.
True
Q7: Making optimal use of local knowledge that is dispersed in the organization requires state-of-the-art knowledge management systems:
True
False
False
Q8: Markets and firms are different because
Firms make use of relatively high-powered incentives, markets of relatively low-powered incentives.
In markets, unlike firms, all property rights are fully delegated.
In markets, individuals are owners, whereas decision rights to corporate resources are only “on loan.”
In markets, individuals are owners, whereas decision rights to corporate resources are only “on loan.”
Q9: Based on agency theory we would predict that a high level of delegation and a low level of risk-aversion of employees are correlated.
True
False.
True
Q10: Digital tools such as big data, predictive analytics, and artificial intelligence will lead to more delegation in firms.
True
False
False
Designing the organization(‘s hierarchy)
Structure:
Tasks and their assignment to individuals and subunits; apportioning resources to units; designating customers, markets to units ( coordination & cooperation needs).
Designing the organization(‘s hierarchy)
Organizational control:
Bringing units together through communication, IT, incentives, culture, routines and procedures … management ( meet the coordination & cooperation needs).
The process of org design
Structure:
Determining work activities and dividing up tasks -> Division of labor
Grouping jobs and employees (units) -> Departmentalization
The process of org design
Control:
Assigning authority and responsibilities -> Delegation
Meeting communication needs -> Information policy
Setting standards -> SOPs, routines, decision criteria
Providing inducements -> Incentive design
What does the contingency theory state?
No universally best form of hierarchy / organization.
”Contingencies” (e.g., technology, dynamism, strategy, etc.) shape what is the best organization.
What does the Configurational Theory state?
Mechanisms that ensure coordination, cooperation in firms tend to cluster in discrete configurations/bundles (e.g., Mintzberg’s five configs).
The essence of hierarchy
Creating specialized units coordinated, controlled by a superior unit!
What means Departmentalization?
Grouping jobs together and defining units, so that similar or associated tasks and activities can be coordinated.
What is span of control / # of hierarchical layers?
How many employees does a manager supervise? How many layers does the hierarchy have?
Types of departmentalization
-Task
-Product
-Process
-Geographic
Span of control. The higher the vertical differentiation… the less
span of control
Advantages and disadvantages about “Narrow span of control”
Advantages:
Higher degree of control
Manager is more familiar with individuals
Close supervision can provide immediate feedback
Disadvantages:
More management levels, more expensive
Slower decision making
Isolation of top management
Discourages employee autonomy
Advantages and disadvantages about “Wide span of control”
Advantages:
Increased efficiency and reduced costs
Quicker decision making
Greater flexibility
Disadvantages:
Less control
Possible lack of familiarity
Managers spread thin
Lack of coordination
What does delayering mean?
Making less layers in the hierarchy to get top managers to delayer to get closer to decision-making
Why are many firms currently delayering their internal organization?
Need for faster, less noisy decision-making b/c of increased competition in product markets (stemming from internationalization, deregulation, innovation).
Need to get closer to customers.
Private equity, active institutional investors that try to cut corporate slack.
Enabled by information technology that reduces communication costs.
Mention 5 hierarchical forms
Simple hierarchy, U-form, M-form, matrix form … or Minzberg’s five configurations
Explain simple hierarchy, (multi)divisional structure (M), functional (U) structure, matrix (multidimensional) structure
:)
Advantages and disadvantages about simple hierarchy
Advantages:
Clear view of organizational goals
Wide spans of control and centralized authority allow quick decision making
Little formalization ensures flexibility
Disadvantages:
Often unfeasible for larger organizations with high variety / complexity of tasks
Depends critically on the CEO
Advantages and disadvantages about Functional (U) structure:
Advantages:
Efficiencies from putting together similar specialties and people with common skills, knowledge, and orientations
In-depth specialization
Coordination within function
Disadvantages:
Risk of poor communication across functional areas
Limited view of organizational goals
«Siloing»
Advantages and disadvantages about Divisional (M) Structure
Advantages:
Allows specialization in particular products, services, geographies
Closer to customers
Facilitates cross-functional collaboration
In-built accountability
Disadvantages:
Duplication of functions
Limits learning / knowledge sharing in functional areas
Can create unwanted rivalry between divisions
Advantages and disadvantages about Matrix:
Advantages
Fluid design that can respond to environmental changes
High information carrying capacity
High degree of coordination
Disadvantages:
Expensive and complex
Dual authority can lead to task and personality conflicts & slow down decision making
What determines org designs?
Potentially everything that impacts on the organization’s need for coordination, cooperation
Size: e.g., as firms grow they rely more on formalization, delegation b/c their internal DoL ↑
Strategy: e.g., which of Porter’s generic strategic the firm follows.
Technology: type of interdependence.
Uncertainty: makes it harder to plan in advance what to do, who should do what, when, where, etc.
Meaning of interdependence
the degree to which individuals interact with and rely on each other to accomplish work.
Mention the four types of interdependence
- Pooled interdependence
- Sequencial interdependence
- Reciprocal interdependence
- Team interdependence
Please think of examples of (types of) firms that exemplify pooled, sequential and reciprocal interdependence in their internal organization.
Pooled: Fastfood chains; much of what Amazon does; some consulting firms; teaching activities in universities; Safelite Glass (Lazear); M-form firms.
Sequential: Car-producers and other firms that make use of assembly lines; U-form firms often have a linear activity flow between units.
Reciprocal: Project-based professional services firms; many research activities in universities; Oticon Spaghetti Org.
Note: Firms can have all sorts of interdependencies within different units, e.g., R&D (reciprocal), production (sequential), logistics, IT-support (pooled).
How do you expect the reward systems be shaped by the prevailing interdependencies? Low or high beta?
Pooled: Individual-level incentives often feasible (e.g., consulting, franchising); unit-level incentives (M-form firm). β can often be high.
Sequential: Hard to measure individual contributions (think workers along an assembly-line). β likely to be low (even 0).
Reciprocal: Unit-level incentives (particularly if units are small, so easy to engage in peer monitoring). β can be relatively high.
The role of uncertainty
Rate the following from low uncertainty to high uncertainty:
- Rules /programs/standard operating procedures
- Hieracrhy
- Targets and goals (employees choose behaviors)
- Targets and goals (employees choose behaviors)
- Hieracrhy
- Rules /programs/standard operating procedures
To extremes of organization design
Mechanistic organizations:
§High degree of specialization
§Rigid division of labor
§Employees focus on narrowly defined tasks
§Intimate familiarity with rules, policies, and processes necessary
§Deep expertise in narrowly defined domain required
§Task-specific knowledge valued
§Decision power centralized at top
§Vertical (top-down) communication
§Tall structures
§Low span of control
§Clear lines of authority
§Command and control
Organic organizations:
§Low degree of specialization
§Flexible division of labor
§Employees focus on “bigger picture”
§Clear understanding of organization’s core competencies and strategic intent
§Domain expertise in different areas
§Generalized knowledge of how to accomplish strategic goals valued
§Distributed decision making
§Vertical (top-down and bottom-up) as well as horizontal communication
§Flat structures
§High span of control
§Horizontal as well as two-way vertical communication
§Mutual adjustment
Q1: U-form hierarchies are likely to exhibit more instances of confirmation bias than project matrix form hierarchies, all else equal:
True
False
True
Q2: U-form hierarchies are preferable to M-form hierarchies from an agency theory perspective:
True
False
False
Q3: A potential incentive cost of a delayered hierarchy is that promotion opportunities are removed.
True
False
True
Q4: For a fixed number of workers, when the span of control is increased, the number of layers in the hierarchy
is reduced.
Is increased.
Doesn’t change.
is reduced.
Q5: A narrow span of control
Means that managers are likely to be more familiar with employees
Are less capable of providing immediate feedback
Means that managers are likely to be more familiar with employees
Q6. Mintzberg’s ”simple structure” is the same as the ”simple hierarchy.”
True
False.
True
Q7: Self-organizing teams always beat hierarchies in terms of flexibility.
True
False
False
Q8: As uncertainty increases, firms will make more use of
Standard operating procedures.
Planning.
Targets and goals and let it be up to employees how they meet these.
Targets and goals and let it be up to employees how they meet these.
Q9: We would expect the use of performance-based rewards to be associated with the use of targets and goals.
True
False.
True
Q10: Delayering may mean that employees become less empowered.
True
False
False
Give examples of boundary decisions
As a defence contractor, we need to order a customized machine which is essential for our completion of a contract.
A specialist is needed to purchase and set up our new management info system; should we use an internal employee or temporarily hire an external specialist?
We need a steady supply of highly specialized machined parts; how do we secure such a supply?
We need to place an order for five reams of copying paper with a local office supply store.
Mention transactions in a vertical chain (computer production). And what is the definition of such transaction?
- Raw materials
- Transportation and storage
- Intermediate - goods processors
- Transporation and storage
- Assemblers
- Trans…
”the transfer of a good or service across a technologically separable interface” (Williamson
Examples of governing transactions
- Make or buy
- Which body of law applies?
- How do we adapt?
- Who owns the assets in the relation?
Mention some core transaction cost ideas:
Ppl are bounded rational.
Ppl are not always trustworthy / honest, but opportunistic.
Transactions differ with respect to how frequently they take place; the uncertainty that surrounds them; and the degree of asset specificity they involve.
Different contractual, organizational arrangements (i.e., «governance structures») necessary for handling different transactions.
Explain opportunism (The self-interested person and The opportunist)):
The self-interested person: focuses on his own interests, while honoring agreements and showing respect for others.
The opportunist: focuses on his own interests, but uses all possible means (dishonoring agreements, manipulating, cheating, stealing, etc.) to achieve them.
Explain bounded rationality
Behavior is “intended rational, but only limitedly so” (Herbert Simon)
Bounded rationality makes contracts incomplete!
If contracts are incomplete, then some contingencies are not included.
Ex post bargaining becomes relevant (not a problem if ppl aren’t opportunistic)
Contracts become incomplete when …
High costs of writing a complex/complete) contract.
Inability to anticipate all possible contingencies
Different interpretations of the same contractual terms.
Some contractual terms may be unverifiable by an independent third party (e.g. a court).
Five types of asset specificity:
- Physical asset specificity
- Site-specific
- Dedicated assets
- Brand names
- Human asset specificity
Explain Asset specificity -> Quasi-surplus/rent:
Specific/specialized assets generate a stream of quasi-surplus, since they aren’t easily redeployable.
Quasi-surplus: the difference between the value of the asset in the current (best) use and its next best use.
Explain the hold up problem
If two parties agrees on an incomplete contract. After some time, one person wants to give up the contract but are then being held up (maybe because he was not considering all aspects).
Why does the hold-up problem create market failures (inefficiencies)?
Market exchange results in underinvestment; U fears being held-up.
The efficient (surplus maximizing) investment is not chosen (U anticipates being held up).
The equilibrium is inefficient because each party could be made better off (20, 20).
Low asset specificity = markets
medium AS = Hybrids
high AS = Hierarchies
Q1: A transaction which is high in uncertainty and frequency, but low in asset specificity is best handled by hierarchy.
True
False
False
Q2: Transactions that require coordinated adaptation are best handled by markets:
True
False
False
Q3: Moral hazard and opportunism both refer to ex post situations (after signing a contract):
True
False
True
Q4: Delta Airlines made a smart move by purchasing the Philadelphia oil refinery, because they would then have lower costs than other airlines if the price of fuel went up.
True
False.
False.
Q5: Firms should make an asset, rather than buy it, if that asset is a source of competitive advantage for the firm.
A. True
B. False
B. False
Q6. One advantage of a hybrid form is that can achieve some of the advantages of hierarchies (such as a good flow of information), while avoiding the costs of managing dissimilar capabilities in the same firm.
True
False
True
Q7: TCE suggests that people are generally opportunists:
True
False
False
Q8: According to TCE, if it wasn’t for opportunism, there wouldn’t be any contractual problems:
True
False.
True
Q9: Hybrid forms are particularly stable in the face of disturbances.
True
False.
False.
Q10: Internalizing a transaction eliminates the transaction costs associated with the transaction:
True
False
False
Explain “supply chain systems” under Subcontracting
Supply chain systems (e.g., Toyota shares substantial decisions regarding the design of its cars with its privileged subcontractors)
Explain “Quasi-integration” under Subcontracting:
(i.e., firms own some of the key assets of their supplies, e.g., the big US auto producers).
Explain “Supplier parks” under Subcontracting:
i.e., a cluster of suppliers located adjacent to, or close to, a final assembly point – physical (e.g., Volkswagen in Brazil) or “virtual” (e.g., Toshiba’s network of 200 direct partners and 600 “grandchild companies”).
Mention two hybrid governance structures:
- Strategic alliances: Relatively enduring cooperative arrangements; partners jointly plan and monitor substantial activities using contracts to coordinate and build relational trust (as in the alliances in the airline industry or biotech/pharma alliances).
- Joint ventures: simultaneously contractual agreements between two or more organizations and a separate legal (and usually organizational) entity with its own purpose.
What is the reason that ToF suggests that diversification may be value-increasing?
Firms tend to accumulate excess resources; strong incentive to monetize these (0 opportunity costs); when market contracts, hybrids fail Related diversification.
Explain economies of scope:
C (x1, x2) < C1 (x1) + C2 (x2)
Why do multi product firms exist?
Partly EoS (Economies of scope), but cannot be the only reason.
Another part of the reason is excess, fungible resources:
Learning and routinization frees resources (e.g., managerial talent, improving coordination release work and machine time, etc.).
Such excess resources may have no opportunity costs (i.e., they are idle).
They may be ”fungible”, i.e., applicable to new, different uses.
Strong incentive to deploy them to such uses, i.e., diversification growth through related diversification.
Mention four causes of Market failure:
- Excess specific physical capital: Hold-up risk.
- Excess specific human capital: Hold-up risk.
- Excess knowledge resources: Costly to articulate tacit knowledge; Arrow’s information paradox.
- Excess financial capital (cash): Managers may have superior knowledge about the attractiveness of certain opportunities than stockholders/the financial market.
What is the dark side of related diversification?
It involves more interdependencies/complexity (cf. Session 6, 7 on departmentalization and interdependencies) more costly to manage.
What causes diversification?
Diversification arises as a response to market failure … but risks shifting transaction costs into the boundary of the firm!
Q1: Outlets that are located closely to the franchisor are more likely to be franchise-operations.
True
False
False
Q2: Hybrids may be classified on the basis of how close to/far from they are from markets or hierarchies.
True (think of the ”pure” market and the ”pure” hierarchy as defining end pts on a spectrum; we can then distribute the various forms on this spectrum)
False
True (think of the ”pure” market and the ”pure” hierarchy as defining end pts on a spectrum; we can then distribute the various forms on this spectrum)
Q3: Wholly-owned outlets have stronger incentives to reduce product quality than franchisee-owned outlets:
True
False
False
Q4: As conglomerates are not based on shared resources, they make zero economic sense.
True
False. (they ”make sense”, among other things, b/c they may be comparatively easy to manage)
False. (they ”make sense”, among other things, b/c they may be comparatively easy to manage)
Q5: In general, as a franchisor you should exploit your bargaining power to the max.
A. True
B. False
B. False
Q6. Relatively less use will be made of markets and hybrids and relatively more will be made of vertical integration in developing countries.
True (there are likely to be more problems of enforcing contracts in such countries)
False
True (there are likely to be more problems of enforcing contracts in such countries)
Q7: Making the franchisee a residual claimant eliminates his incentives to moral hazard:
True
False (reduces, but doesn’t eliminate the incentives; there are still incentives to free-ride on the brand)
False (reduces, but doesn’t eliminate the incentives; there are still incentives to free-ride on the brand)
Q8: An expansion of the horizontal boundaries of the firm in the form of a diversification move is best organized by a M-form hierarchy.
True (this keep complexity relatively low)
False.
True (this keep complexity relatively low)
Q9: Firms with a high degree of unrelatedness in the product portfolio are likely to have many complex interdependencies.
True
False.
False.
Q10: Adding a new business to a conglomerate form will be more costly than adding a new business to a related diversifier.
True
False
False
What are the two notions of ownership?
- residual income perspective
Ownership gives the right to residual income - i.e., an ”owner” is a residual claimant (finance notion of ownership). - residual rights perspective
Ownership gives the right to make residual decisions – i.e. decisions over uses of assets that are not stipulated in a contract (“property rights approach”).
Ownership implies that you have..
bargaining power
Why are contract, internal legal systems necessary?
Because opportunism, moral hazard exist under integration – e.g., supply divisions may not deliver the right amount, quality, etc.
To who falls ownership (those who transact with a firm)
Capital suppliers.
Customers.
Input suppliers.
Workers.
Government.
No one (non-profits).
Which patrons should ow the firm?
Balance the costs of contracting (with non-owning patrons) and the costs of ownership (for owning patrons).
The patron group for which the sum of these two costs is lowest is the efficient owner-group.
Explain the cost of contracting, and cost of ownership
Costs of contracting (with non-owners):
Monopoly or monopsony.
Contractual lock-in.
Relation-specific assets (as in TCE/Williamson; Session 8).
Asymmetric information.
One party has specialized knowledge that can be used to exploit the other party (moral hazard etc.).
Costs of ownership (for owning patrons):
Monitoring (agency) costs.
All else equal, patrons who are least-cost monitors are most efficient owners.
Collective decision-making.
How to aggregate the interests of members of a patron class?
Risk bearing.
Which patron class is in the best position to bear risk?
A “capitalists cooperative” emerges when …
Lenders are particularly likely to have their capital at risk/appropriated b/c of opportunism/moral hazard from other patrons, particularly when the firm needs to undertake long-term investments, requiring long-term financing.
Risk diversification benefits of investor ownership.
Common denominator of profit/max NPV of firm reduces costs of decision-making.
Q1: The firm’s owners are the shareholders.
True
False
False
Q2: The costs of ownership are.
Monitoring costs, risk-bearing, and costs of collective decision making.
Monitoring costs, costs of collective decision making, and contractual lock-in costs.
Risk-bearing, hold-up costs, and cost of collective decision making.
Monitoring costs, risk-bearing, and costs of collective decision making.
Q3: Because the members of Lego’s open innovation communities make relation-specific investments when they offer suggestions for how to improve Lego products, etc., they should have an ownership stake in Lego:
True
False
False
Q4: In the property rights approach, the boss has authority over a worker because he can deprive him of the assets he works with.
True
False.
True
Q5: In the property rights approach, the investment level depends on the governance structure.
A. True
B. False
A. True
Q6. If in a relation a party is asked to make a specific investment, some way should be found to strengthen that party’s bargaining power
True
False
True
Q7: Integrating two parties will usually strengthen the incentives of both parties to make relation-specific investments.
True
False
False
Q8: If two parties in a relation both make specific investments, and one of the parties makes investments that have small implications for value creation, this party should assume ownership of the assets:
True
False.
False.
Q9: All firm ownership arrangements may be analyzed as cooperatives.
True
False.
True
Q10: In banks, loan officers increasingly make customized rather than vanilla loans. This is likely to give them less bargaining power.
True
False (making customized loans means that you are getting bargagining power b/c you get more control over key customer relationships)
False (making customized loans means that you are getting bargagining power b/c you get more control over key customer relationships)
Mention factors that can enforce agreements to coop & coord.
- Law, courts, ultimately backed up by state power
- Trust
- Social norms
- The Blockchain
- Adopting a “we-attitude”
- Self-enforcing agreements
- Reputation
- Theats backed up by private power (hierarchy)
Mention 3 contractual hazards
- Problem of opportunism
- moral hazard
- hold-up.
How can contractual hazards be avoided?
contracting with multiple suppliers (Cluj Hardware exercise), termination for convenience clauses (franchising), owning assets used by supplier (franchising, some supplier relations), etc.
Explain “shading” in a contract:
Dissatisfied party cuts down on cooperativeness, ceases to be proactive, doesn’t invest in the relationship.
Not really opportunism, moral hazard; happens b/c the party isn’t getting the outcome it expected from the deal and feels the other party is to blame.
Mention mechanisms that can enforce (make it work) a contract:
- Adopt a ”What’s in it for We” mentality.
- Transparency about aspirations, goals and concerns—e.g., by having relevant counterparts from the different companies mutually clarify this.
- Co-create the goals of the relation.
- Irreversible threats
- hostages
(Chpt 8 / session 8 example: Hold-up problem: In the equilibrium of the game, the efficient investment will not be made (0,0). But what if the downstream firm posts a valuable ”hostage” (e.g., a bank deposit) before the game starts.)
What is the definition and idea behind self-enforcing agreements?
Aself-enforcing agreementis an agreement or contract between two parties that is enforced only by those two parties (third party enforcement is not involved). This agreement stands so long the parties believe it is beneficial and is not breached by either party.
Underlying self-enforcing agreements is that parties make ”cheating” (engaging in moral hazard, opportunism) expensive.
Cf. earlier examples (the Henry Ford 5-dollars day, McDonald’s leaving rents to their franchisees, …).
What does the Folk Theorem has to do with the prisoners dilemma?
Folk theorem resolves the prisoners dilemma … Because it introduces reciprocity (i.e., current “bad behaviour” can be punished in the future) in the players’ strategies.
This can sustain the efficient outcome (2,2), so both players get:
What is the Tit-for-tat strategy?
Start playing nicely (S); subsequently choose the same action that the other player just took.
What is the grim strategy?
Start playing S; continue to do so as long as the other player plays S. If he plays T, reciprocate with T forever.
Mention advantages of self-enforcing agreements:
Save on transaction costs,
Contract drafting costs.
Costs of using of third-party enforcement.
Allows for contracting when third-party enforcement is not possible.
Allows for more flexibility.
Sometimes more incompleteness is better than less, e.g., when
clauses can be used as levers for opportunism (e.g., cost-plus contracts);
the prevailing contract law insists on full adherence to the terms of the contract.
the parties expect that they will only know later what exactly they need, want (e.g., ”Statements of Work” in IT development contracts).
Q1: Two players cooperate by means of a self-enforcing contract. The discount rate used by the players declines (for whatever reason). This will make their relation more stable.
True
False
True
Q2: If sunk costs are zero, markets and vertical integration may, according to property rights theory, both realize efficient investments.
True
False
True
Q3: Diversifying by adding a closely related business decreases internal complexity.
True
False
False
Q4: Transaction cost economics assumes
Incomplete contracts, bounded rationality, and moral hazard
Incomplete contracts, bounded rationality, and opportunism
Incomplete contracts, opportunism, and confirmation bias.
Incomplete contracts, bounded rationality, and opportunism
Q5: According to organization design theory, elements of org design (e.g., departmentalization, delegation, incentives, etc.) can be combined in a highly flexible manner.
A. True
B. False
B. False
Q6. The costs of delegation are:
Decreasing motivation and agency costs.
Agency costs, and less efficient use of local knowledge
Agency costs and difficulties of coordinating interdependent activities.
Agency costs and difficulties of coordinating interdependent activities.
Q7: Ownership is
The right to derive residual income from an enterprise.
The right to control asset uses (that are not specified in contracts).
Both A) and B).
Both A) and B).
Q8: The advantage of a reward system with a high β is that it ”runs itself”; managers basically don’t need to engage in monitoring.
True
False.
False.
Q9: The Coase theorem holds true only under conditions of
Zero transaction costs, no wealth effects, and perfect competition.
Zero transaction costs and perfect competition.
Zero transaction costs and no wealth effects.
Zero transaction costs and no wealth effects.
Q10: Tightly coupled, flat organizations adapt more quickly and at lower cost than hierarchical orgs:
True
False
False
Q11: Organizations departmentalize based on the following criteria:
Agency costs
Task, agency cost, product, geography
Task, geography, product, and process
Task, geography, product, and process
Q12: In TCE, governance structures include:
Markets, backward integration, forward integration
Markets, hierarchies and hybrid forms.
Markets, hierarchies, and the state.
Markets, hierarchies and hybrid forms.
Q13: Bilateral relations with high levels of asset specifity will inevitably break down:
True
False
False
Q14: The higher the vertical differentiation the smaller the span of control.
True
False
True
Q15: Delayering means that employees have more decisions delegated to them.
True
False
False
How to solve an exam question? (6 steps)
- “What is (probably) going on here?”
- Which theoretical tool(s) is (probably) useful?
- Identify the players that are involved in the case situation. What do they know? Motivation/incentives? Interaction?
- Analyze the situation, using the theory(ies)
- Provide your recommendations for improving the situation (if it can be improved).
- Discuss some limitations of your analysis/ recommendations.
Draw the Monopoly model
Look at slide
