Exam prep Flashcards
Nash Equilibrium requires that there are many players
False
When asymmetric information is introduced into a game, this typically
changes the strategy set and changes the outcome of the game
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
In a game, the number of subgame perfect equilibria will always be higher than the number of Nash equilibria
False
In a classical decision theory, decision-makers have unstable, preferences, limited attentional and computational capacities, and their behaviors are driven by expectation of consequences
False
Loss aversion means that A) we pay more attention to nonrecoverable costs (and potential losses) when considering future actions, B) We feel losses more acutely than gains of the same amount, C) We root our thinking in an initial value and, fearing loss, we fail to sufficiently adjust our thinking away from that value
B) We feel losses more acutely than gains of the same amount
Excessive optimism and overconfidence are examples of stability biases:
False
When we seek to find the subgame perfect equilibrium of a game, we A) Start at the bottom of the extensive from game and solve by means of backward induction, B) Start at the top of the extensive form game and solve by means of forward deduction, C) Add players to the game
A) Start at the bottom of the extensive from game and solve by means of backward induction
Cognitive biases are always problematic (i.e., reduce value creation) to firms
False
In game theory, “strategies” are those actions of a player that are not conditioned on what others do:
False
The first Welfare theorem says that any efficient allocation can be decentralized as a competitive equilibrium
False
In the world described by the First Welfare theorem, there are no cooperation problems bu there may be coordination problems
False
Cognitive biases may be a source of bargainin costs
True
The Coase theorem assumes that: A) Transaction costs are zero, B) Transaction costs are zero and there are no wealth effects, C) The sub-game perfect equilibrium will always be optimal
B) Transaction costs are zero and there are no wealth effects
The first welfare theorem and the coase theorem: A) Describe realistic theoretical ideals, B) Present imaginary worlds in which markets don’t exist, C) Describe the conditions under which first best efficient outcomes can be reached
C) Describe the conditions under which first best efficient outcomes can be reached
A key implication of the Coase theorem is that the more complete a contract, the further away we get from efficiency (all else equal)
False
The Coase Theorem implies that the closer we get to full information, the closer we get to efficiency (all else equal)
True
When transaction costs are really high, firms are highly flexible
False
When there are transaction costs and welath effects, efficiency has no meaning
False
Firms cannot use the price mechanism inside their hierachies, as prices onlu make sense in a market
False
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 interes
The agency problem describes a sitution where the Coase theorem doesn’t hold
True
In agency theory, contracting is such that the parties can perfectly observe each others’ actions
False
In agency theory, monitoring and incentives are alternative
True, False
The efficient agency contract A) Meets the participation constraint, B) Has zero welath effects, C) Meets the participation and the incentive constraints
C) Meets the participation and the incentive constraints
A high beta 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 effort is rather ambigious and the agents only engages in one or only a few tasks
A) When agents are low in risk aversion and their efforts are highly responsive to incentives
A low beta in the wage equation means that the firms are more likely to recruit high-performers
False
Adopting a high-powered incentive system (high beta) means that the management need to care less about rewards
True, False
The tradeoff between incentives and insurance can be influenced by, e.g., management info systems
True
Firms that delegate more will have more agency problems
True
An agent’s utility of W depends on var (W), even if E (W) stays constant
True
Lazear’s analysis suggests that firms should in general adopt pay-for-performance
False
Jensen & Murphy’s findings suggests that firms should in general adopt pay-for performance
Fasle
Jensen & Murphy’s findinds suggest that the agency problem in US corporate governance is small
False
In Lazear’s analysis of incentives, Var (output/employee) was reduced
False
A low beta in the wage equation make sense when A) Employees work independently, B) jobs involve a low level of multitasking, C) Individual productivities are difficult to measure
C) Individual productivities are difficult to measure
In Safelite glass, the increase in beta led to less employee sorting in and out of the firm
True
According to Jensen and Murphy, the link between CEO pay and shareholder wealth is weak because, A) CEOs are risk-averse, B) The public dislikes high CEO pay, C) Boards are very good at (input-)monitoring CEOs so that they don’t need to tie pay and firm performance together
B) The public dislikes high CEO pay
In agency theory, the contracting problem is that the principal fails to anticipate certain contingencies
False (the P anticipates all possible contingencies but does not what exactly the agent did and the realization fo the random vairable)
Inefficiency in a PA relationa rises because A) The parties face asymmetric information, B) Becuse of teh agent’s risk aversion, C) 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
C) 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
In Jensen & Murphy’s analysis, relatively low executive pay is partly compensated by a high risk of dismissal:
False
In the agency problem, the risk premium A) Is a cost that emerges because of different risk preferences and asymmetric information, B) compensates the agent for the loss in utility he suffers when Var (W) increases, C) varies positively with beta, D) A and B, E) B and C, F) A, B and C
F) A, B and C
Jensen and Murphy demonstrates that when the beta faced by executives increases, this causes a gain to shareholders
False
In agency theory, it is costless to write a contract
True
Employees generally prefer piece rates because this pay arrangement increases their income
False
Two employes 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
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
False
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 10h2, 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.
C. 7 hrs
B. 5 hrs. Differentiate 100h-10h2 and set equal to 0; then h = 5).
Delegation is likely to lead to increase of beta in the linear wage equation
True
When information is symmetric, delegation increases the agency problem
False
Optimal delegation A) equalie the toal costs and benefits of delgation, B) equalizes the marginal costs and benefits of delegation, C) Means that all local knowledge in the firm is exploited
B) equalizes the marginal costs and benefits of delegatio
The more specialized job functions are, the more delegation
False
Firms in fast-moving industries are likely to have a higher level of delegation
True
Delegation may itself reduce agency costs
True
Making optimal use of local knowledge that is dispersed in the organization requires state-of-the-art knowledge management systems
False
Markets and firms are different because
A. Firms make use of relatively high-powered incentives, markets of relatively low-powered incentives.
B. In markets, unlike firms, all property rights are fully delegated.
C. In markets, individuals are owners, whereas decision rights to corporate resources are only “on loan.”
C. In markets, individuals are owners, whereas decision rights to corporate resources are only “on loan.”
Based on agency theory, we would preduct a high level of delegation and a low level of risk aversion of employees are correlated
True
Digital tools such as big data, predictive analytics, and AI will lead to more delegation in firms
False
U-form hierarchies are likely to exhibit more instances of confirmation bias than project matrix form hierarchies, all else equal
True
u_form hierarchies are preferable to M-form hierarchies from an agency theory perspective
False
A potential incentive cost of delayered hierarchy is that promotion opportunities are removed
True
For a fixed number of workers, when the span of control is increased, the number of layers in the hierarchy A) is reduced, B) is increased, C) doesn’t change
A) is reduced
A narrow span of control
A) means that managers are likely to be more familiar with employees
B) are less capable of providing immediate feedback
A) means that managers are likely to be more familiar with employees
Mintzberg’s “simple strucutre” is the same as the “simple hierarchy”
True
Self-organizing teams always beat hierarchies in terms of flexibility
False
As uncertainty increases, firms will make more use of
A) standard operating procedures
B) planning
C) Targets and goals and let it be up to employees how they meet these
C) Targets and goals and let it be up to employees how they meet these
We would expect the use of performance-based rewards to be associated with the use of targets and goals
True
Delayering may mean that employees become less empowered
False
A transaction which is high in uncertainty and frequency, but low in asset specificity is best handled by hierachy
False
Transactions that require coordinated adaptation are best handled by markets
False
Moral hazard and opportunism both refer to ex post situations (after signing a contract)
True
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
False
Firms should make an asset, rather than buy it, if that asset is a source of competitive advantage for the firm
False
One advantage of a hybrid form is that it 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
TCE suggests that people are generally opportunists
False
According to TCE, if it wasn’t for opportunism, there wouldn’t be any contractual problems
True
Hybrid forms are particularly stable in the face of disturbances
False
Internalizing a transaction eliminates the transaction costs associated with the transaction
False
Outlets that are located closely to the franchisor are more likely to be franchise-operations
False
Hybrids may be classified on the basis of how close to/far from they are from marekts 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 froms on this spectrum)
Wholly-owned outlets have stronger incentives to reduce product quality than franchise owned outlets
False
As conglomerates are not based on shared resources, they make zero economic sense
False
In general, as a franchisor you should exploit your bargaining power to the max
False
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)
Making the franchise a residual claimant eliminates his incentives to moral hazard
False (reduces, but doesn’t eliminate the incentives; there are still incentives to free-ride on the brand)
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 low)
Firms with a high degree of unrelatedness in the product portfolio are likely to have many complex interdependencies
False
Adding a new business to a conglomerate form will be more costly than adding a new business to a related diversifier
False
The firm’s owners are the shareholders
False
The costs of ownership are
A) Monitoring costs, risk-bearing, and costs of collective decision-making
B) Monitoring costs, costs of collective decision making, and contractual lock-in costs
C) Risk-bearing, hold-up costs, and cost of collective decision making
A) Monitoring costs, risk-bearing, and costs of collective decision-makin
Because the members of Lego’s open innovation communities make relation-specific investments when they offer suggestions for how to improve Lego product, etc., they should have an ownership stake in Lego
False
In the property rights approach, the boss has authority over a worker because he can deprive him of the assets he works with
True
In the property rights approach, the investment level depends on the governance structure
True
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
Integrating two parties will usually strengthen the incentives of bot parties to make relation-specific investments
False
If two parties in a relation both make specific invesrtments, and one of the parties makes investments that have small implications for value creation, this party should assume ownership of the asset
False
All firm ownership arrangements may be analyzed as cooperatives
True
In banks, loan officers increasingly make customized rather than vanilla loans. This is likely to give them less bargaining power
False (making customized loans means that you are getting bargaining power because you get more control over key customer relationships)
What is loss aversion?
A bias in the category: Framing of alternatives. Means that losses are felt more acutely than gains of the same amount
What is escalation of commitment?
A bias in the category: Framing of alternatives. Investing additional resources in an apparently losing proposition b/c of what we already invested
What is Confirmation bias?
place too much weight on evidence consistent with favored belief
What is groupthink?
Conformity-seeking makes us disregard alternatives
Knowledge bias?
We assume others know what we do
What does excessive optimism mean?
Means that we overestimate p (positive events), underestimate p(negative events) (action-oriented bias)
What does self-serving bias cover?
We overestimate our skill level relative to others, how much we contributed to joint efforts and out contribution to positive outcomes
What is status quo bias?
Prefer things (etc) in their current state
What is present bias?
We value immediate rewards very highly, undervalue long-term gains
What does endowment effect mean?
We ascribe more value to things when we own them
Orange picking exercise: Why pay per tree (instead of, say, a flat wage)?
Possible answer: High-powered incentive that reduce the need to observe/monitor individual agents
Orange picking exercise: Why pay the team (rather than the individual)?
Possible answer: Less expensive to observe team output than individual output
Orange pricking exercise: Why let the team distribute the rewards?
Possible answer: Team-members can better observe individual productivity than a manager is capable of. They can motivate each other by varying pay
Orange picking exercise: Would fruit pickers prefer this mode of organization (team-based pay-per-tree reward)?
Possible answer: Probably; it saves on the costs of solving motivation problems. The savings may be shared between the team and the owner
1st Welfare theorem:
If x, y, z … then the resulting allocation of goods and services is Pareto optimal
1: each firm maximises its profits; knowing the prices and its own production technology
2: each consumer maximises utility; knowing the prices and his own preferences
3: income and prices are such that demand equals supply for every good and service
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)
3) the action the agent will take spontaneously is not opitmal (inefficiency)
What is the agent’s wage equation?
W=W0+beta(e+theta)
What did Lazear’s study show?
Implemeted piece rate:
Output per worker incresed dramatically
Firm-level output increased
Profits and wages increased
Var (ouput/worker) increased (more able/ambitious workers increased their output more)
Able/ambitious workers selected into the firm (“sorting”) (average ability increased)
Centralized firm good at (accepting/rejecting) projects
rejecting projects but will also reject more good projects
Decentralized firm good at (accepting/rejecting) projects?
accepting projects but will also accept more bad projects
What are the benefits & costs of delegation?
Benefits:
- Economiing with managerial time
- Speedy decision making
-Motivation
- Utilizing “local” (tacit” knowledge
Costs:
- Agency costs
What are the advantages of a narrow span of control?
- Higher degree of control
- Manager is more familiar with individuals
- Close supervision can provide immediate feedback
What are the disadvantages of a narrow span of control
- More management levels, more expensive
- Slower decision making
- Isolation of top management
- Discourages employee autonomy
What are the advantages of a wide span of control?
- Increased efficiency and reduced costs
- Quicker decision making
- Greater flexibility
What are the disadvantages of a wide span of control?
- Less control
- Possible lack of familiarity
- Managers spread thin
- Lack of coordination
What are the advantages of “Simple hierarchy”?
.- Clear view of organizational goals
- Wide spans of control and centralized authority allow quick decision making
- Little formalization ensures flexibility
What are the disdvantages of simple hierarchy?
- Often unfeasible for larger organizations with high variety/complexity of tasks
- Depends critically on the CEO
What are the advantages of a functional structure?
- Efficiencies from putting together similar specialties and people with common knowledge, skills and orientations
- In-depth specialization
- Coordination within function
What are the disadvantages of a functional structure?
- Risk of poor communication
- Limited view of organizational goals
- Siloing
What are the advantages of a divisional structure?
- Allows specialization in particular products, services, geographies
- Closer to customers
Facilitates cross-functional collaboration - in-built accountability
What are the disadvantages of a divisional structure?
- Duplication of functions
- Limits learning/knowledge sharing in functional areas
- Can create unwanted rivalry between divisions
What are the advantages of matrix?
- Fluid design that can respond to environmental changes
- High information carrying capacity
High degree of coordination
What are the disadvantages of matrix?
- Expensive and complex
- Dual authority can lead to task and personality conflicts and slow down decision making
Examples of firms with pooled interdependencies in their internal organization?
Fastfood chains, much of what Amazon does, some consulting firms, teaching activities in universities, Safelite glass; M-form firms
Examples of firms with sequential interdependencies in their internal organization
Car-producers and other firms that make use of assembly lines, U-firms often have a linear activity flow between units
Examples of firms with reciprocal interdependencies in their internal organization?
Project-based professional service firms; many research activities in universities, oticon spaghetti
How do you expect the reward systems be shaped by the prevailing interdependencies? Pooled
Individual-level incentives often feasible (e.g., consulting, franchising); unit-level incentives (M-form firm). beta can often be high
How do you expect the reward systems be shaped by the prevailing interdependencies?Sequential
Hard to measure individual contributions (think workers along an assembly line) beta likely to be low (even 0)
How do you expect the reward systems be shaped by the prevailing interdependencies? Reciprocal
unit-level incentives (particularly if units are small, so easy to engage in peer monitoring). Beta can be relatively high
Place:
-Hierarchy
- Rules/programs/standard operating procedures
- Targets and goals (employees choose behavior)
possibly supplemented with: slack resources, self-contained tasks, info systems, lateral relations
on a scale from low uncertainty to high uncertainty
From high to low uncertainty:
- Targets and goals (employees choose behavior)
possibly supplemented with: slack resources, self-contained tasks, info systems, lateral relations
-Hierarchy
- Rules/programs/standard operating procedures
What are the core transaction cost economics ideas?
Ppl are bounded rational
2) Ppl are not always trustworthy/honest, but opportunistic
3) Transactions differ with respect to how frequently they take place; the uncertainty that surrounds them; and the degree of asset specificity they involve
4) Different contractual, organizational arrangements (i.e., governance structures) necessary for handling different transactions
Quasi surplus is …
… the difference between the value of the asset in the current (best) use and its next best use
low asset specifity: (generally Market, Hierarchy or Hybrid?)
Medium AS: (generally Market, Hierarchy or Hybrid?)
High AS: (generally Market, Hierarchy or Hybrid?
Low AS: Market
Medium AS: Hybrid
High AS: Hierarchy
Who says that excess resources deployed within firms, resulting in expansion (diversification), when market contracting is not feasible?
Teece. So diversification is a result of market failure
Who says that learning and routinization frees resources, which the firm has strong incentive to deploy to diversifiaction
Penrose
What are the two hypothesis set forth in Zhou’s article on the consequences for diversification?
H1: Firms with high complexity in their existing business lines are less likely to engage in new diversification moves
H2: This effect is reinforced when the new business shares more inputs with the existing business lines (as complexity is further increased)
i.e., the more the primary and target industries share inputs, the higher the p (diversification move); complexity is negatively associated with the p (diversification move); input similarity magnifies the negative relation between complexity and the p (diversification move)
Tit-for-tat strategy
Start playing nicely; subsequently choose the same action that the other player just took
The grim strategy
Start playing nice; continue to do as long as the other player plays nice. If he does not play nice, reciprocate with playing bad all the time
What are the advantages of self-enforcing contracts?
1) Save on transaction costs, contract drafting costs. Costs of using a third-party enforcement
2) Allows for contracting when third-party enforcement is not possible
3) Allows for more flexibility
4) Sometimes more incompleteness is better than less .. see slide
The blockchain and transaction costs: Impact on ex ante transaction costs:
1) reduces costs of assessing trusthworthiness of transaction partners; willingness to commit to the blockchain itself a signal
2) Potential huge set-up costs
The blockchain and transaction costs: Impact on ex post transaction costs:
1) Reduces costs of monitoring
2) Reduces costs of dispute resolution (everything is transparent)
The blockchain and transaction costs: Impact on ex post transaction costs:
1) Reduces costs of monitoring
2) Reduces costs of dispute resolution (everything is transparent)
The blockchain and transaction costs: Impact on ex post transaction costs:
1) Reduces costs of monitoring
2) Reduces costs of dispute resolution (everything is transparent)
The blockchain and transaction costs: Impact on ex post transaction costs:
1) Reduces costs of monitoring
2) Reduces costs of dispute resolution (everything is transparent)
The blockchain and transaction costs: Impact on ex post transaction costs:
1) Reduces costs of monitoring
2) Reduces costs of dispute resolution (everything is transparent)
Business people often argue that firms should make rather than buy inputs to production in order to avoid paying unnecessary profits to suppliers (the “keep profits to yourself” motive). This line of thinking is likely to be:
A) Sound
B) Misguided
Misguided is correct. It is true that sometimes accounting profits (revenues – expenses) can be earned from backward integration (i.e., make). However, this does not necessarily mean that economic profits (accounting profits from preferred activity minus accounting profits from investing the same resources in the best alternative activity) are increased by integration. Second, perhaps suppliers makes high profits; however, this may be because they rely on very scarce skills and expertise that cannot be replicated by the downstream firm. Or, if it seeks to acquire the upstream supplier, it may have to pay a price that reflects the relevant profits. It may be better off paying the “high” price charged by the suppliers. Third, TCE suggests that vertical integration is “the option of last resort.” Making use of high-powered market incentives means that production costs can be kept down.
QUESTION 2 of 7: Acme Corp is a medium-sized multinational firm with approximately 1,500 employees and four main business areas (software for online gaming, lead mining, facility services, and accounting services). Acme is now in the process of redesigning its reward systems. Acme management’s thinking about how to reward individual employees starts from the linear wage equation (W = + ( e + x + y)), but in addition to considering the size of + , Acme also wants to include a variable, “y”, which it interprets as the average effort of all other employees than the focal employee. In other words, a given employee is to be rewarded partly depending on the average effort of all his or her colleagues ( is a parameter that indicates the weight of y). Given Acme’s characteristics, this approach is likely to be
A. Sound
B. Misguided
Answer: B is correct. Acme is trying to introduce comparative performance assessment in their reward systems. They specifically think of y as the average effort of all other employees than the focal employee. Agency theory suggests that doing this makes sense if including this measure improves Acme’s estimate of the effort of a given employee. Supposing that Acme cannot exactly observe the effort of an employee but only a signal, z, will adding y (i.e., z +y) improve Acme’s estimate? (Technically, this is the case if Var (z + y) < Var (z) Cov (z, y) > 0). This is likely to be the case if the efforts of employees are impacted by randomness/noise in a similar way (e.g., all salespeople are hit in the same way by a change in demand); then noise can be “filtered out”, when the employers are evaluated and comparisons across employees are used to assist the evaluation. The problem is that Acme is essentially a (small) conglomerate. They are active in very different business areas. The problem is that because of this, a measure of average effort is likely to pick up randomness that is specific to each individual business area. Therefore, using the average effort across the company in evalution is likely to make the evaluation of any given employee highly noisy, i.e., it imposes additional risk on the employee
Tube is a major Canadian company in the dynamic online computer games industry. Tube offers its games on its platform Fire. Tube is a medium sized firm with 232 employees, mostly software developers and engineers. Developing a game typically begins from defining the development work in terms of big “chunks” of code and integrating these chunks when the development work has been done. The finished software product is then launched directly on Fire. Tube is best served by a
A. Professional bureaucracy.
B. Simple structure.
C. Adhocracy.
D. Machine bureaucracy.
E. Divisionalized form
Tube is likely best served by an adhocracy which according to the Mintzberg article in the readings engages sophisticated specialists and requires them to combine their efforts in project teams coordinated by mutual adjustment and directed towards an innovative output that is launched in dynamic environment (e.g., a new computer game). This is most likely exactly what goes on in Tube (the wording suggests that software “chunks” are handled by parallel project teams). All other forms differ in various ways from Tube (e.g., professional bureaucracies do not typically make use of mutual adjustment and their specialists work independently; divisionalized forms have highly separate units; the machine bureaucracy is very heavy on the admin side and is typically the form assumed by traditional industrial companies; etc.).
The sophisticated answer may also raise issue such as whether the launching of new games is done by a separate unit or done directly by projects once the development work is done and how this could complicate the answer.
Stack ranking is a human resource management practice which involves ranking all employees according to their performance. Often this takes the form of forcing managers to regularly rank employees on a bell curve (normal distribution) of productivity and fire those employees on the segments of the curve furthest to the left. Popularized by Jack Welch at General Electric in the 1980s, stack ranking has been implemented by companies such as Yahoo and Amazon. It has, however, increasingly fallen out of favor among companies. The reasons arguably are these:
A. Stack ranking is destructive for workplace morale, helping behaviors, and may imply high costs of hiring employees.
B. While stack ranking may to some extent increase average employee productivity, it is also likely to be associated with high agency costs.
C. Both A and B.
C) is correct. It is intuitive that stack ranking is likely to be “is destructive for workplace morale, helping behaviors, and may imply high costs of hiring employees” as a key purpose of stack ranking is to continuously increase aggregate work productivity by increasing competition between employees. Hence, A) must be the case.
However, stack ranking is also likely to be associated with high agency costs (i.e., B is also the case). Part of agency costs are the costs of monitoring agents’ actions and learning their abilities which is relevant in the context of hiring new employees (reference to turnover and sorting is warranted here, cf. the Lazear article in the readings).
Stack ranking presupposes monitoring of agents. Placing agents/employees along a curve of productivity may imply precise monitoring of their productivities. Such objective performance assessment is likely to be costly. If it is not possible to precisely monitor productivity, subjective performance assessment will take place which is costly in terms of managerial monitoring effort. Also, employees may perceive such assessment as noisy and as therefore associated with higher perceived risk. They may require a risk premium to compensate them.
To the extent that management in a firm with a stack ranking system still wants employees to, e.g., engage in helping behaviors, it is likely to incur substantial agency costs from trying to call forth and monitor such behaviors (which happen more “naturally” in a less competitive system).
The well-known fact that the distribution of performance is typically not normally distributed may also be mentioned as a problem associated with stacking (one that is particularly important for understanding the incentives of high-performers).
In sum, C) is the correct answer.
The German company Acme Messgeräte produces highly advanced, unique, and specialized measurement instruments for use in the chemical industry. Acme distributes the instruments through independent sales agents that distribute the instruments on specified geographical markets. The agents work under identical economic terms. Specifically, according to their contracts with Acme each agent must sell 10 units of each instrument at a price of 200,000 Euros. The per unit price at which the agents purchase the instruments from Acme is 100,000 Euros. Each agent sells exactly 10 units per year, pays 500,000 Euros in yearly rent for the use of classy showrooms and office space, and make a yearly investment of 100,000 Euros in making the showrooms highly specific so as to best showcase Acme’s instruments. Each agent also makes a yearly investment of 300,000 Euros in training their employees in the proper use of Acme’s instruments so that they can better demonstrate the use of the instruments to prospective buyers.
Acme consider raising the price on their instruments. Given the above description
A. The quasi-surplus/rent in the relation is 100,000 Euros/agent and the price per instrument at which an agent is indifferent between buying from Acme and quitting the relation is 110, 000 Euros.
B. The quasi-surplus/rent in the relation is 300,000 Euros/agent and the price per instrument at which an agent is indifferent between buying from Acme and quitting the relation is 150, 000 Euros.
C. The quasi-surplus/rent in the relation is 400,000 Euros/agent and the price per instrument at which an agent is indifferent between buying from Acme and quitting the relation is 120, 000 Euros.
D. The quasi-surplus/rent in the relation is 500,000 Euros/agent and the price per instrument at which an agent is indifferent between buying from Acme and quitting the relation is 150, 000 Euros.
D) is correct. It is clear from the wording that the relation between Acme and its agents is one that is currently ongoing (“the agents work” etc.). In other words, investments have been made, and Acme may be seen as contemplating how it can leverage its bargaining power in the relation to its own advantage. The quasi-surplus is the value that the party possessing bargaining power in a (bilateral) relation can appropriate and still leave the other party indifferent between leaving or staying in the relation. In this case the quasi-surplus is 500,000 Euros/agent. This corresponds to Acme raising the price from 100, 000 to 150,000 Euros for each measurement instrument (50,000 Euros for each of the 10 instruments = 500, 000 Euros). Acme earns 1,000, 000 / agent, but an agent only quits s/he pays 1,500, 000. This is the simply way to conclude that the quasi-surplus must be 500, 000 Euros.
Alternatively, suppose that it costs an agents x to buy the 10 instruments from Acme. There are two alternatives: A, stay in the relation, and B, quit the relation.
A: An agent’s situation if s/he stays in the relation is: 2,000, 000 – (x + 500,000 + 400,000) = 1,100,000 – x
B: An agent quits when all of the sunk costs is appropriated (plus a tiny bit more), i.e., when the 400, 000 is appropriated by Acme.
I.e., the agent will quite the relation when 1, 100, 000 – x < -400,000 x > 1,500, 000
In other words, the Acme can appropriate (up to) the sunk costs plus the profits (500, 000) which at a price per instrument of 150,000 leaves each agent just indifferent between quitting and staying.
