Quiz #4 Flashcards
Explain what principles and agents are. Why do principles hire agents? What is agency theory?
• Principle - someone who has authority over the performance of certain tasks
• Agent - someone who the principle hires, and delegates authority
◦ Agency Theory is how principles and agents interact
• Why do principles hire agents? (Simply put agents are to be the means to some of the principals’ ends)
◦ 1) they are capable of performing tasks but are too busy/time would be better spent doing something else
◦ 2) they are incapable of performing tasks due to lack of experience/knowledge
What is the agency problem? Why does it occur?
when a manager steals from shareholders occurs because of:
• misaligned interests = P and A have different goals
• information asymmetry = one person has better/more information available
• opportunism = the chance to take advantage of someone
What is agency risk?
• when the agent takes advantage of the principle because:
◦ 1) their interests are misaligned (agents have own ends that differ form principles)
◦ 2) Information asymmetry exists favouring the agents (use this knowledge to their advantage)
What is adverse selection?
exists prior to the hiring of an agent. Candidate presents themselves in glowing terms, may be difficult to determine who is truly qualified. Principle may have a hard time completely verifying the agent’s abilities prior to entering a contract with them. The agents know something that the principle doesn’t, so what the principals don’t know might hurt them.
What is moral hazard?
the potential for moral hazard exists after the hiring of the agent. This occurs when the agent is hired but unwilling to do the assigned tasks, likely to conceal their behaviour. The agent can get away with it either because the principle is unable to observe (when it is difficult to assess whether the agent is faithfully putting forth effort) the agent’s behaviour or because they are unable to judge (this could be due to lack of background making it difficult to assess their behaviour) their behaviour. **A minor example of moral hazard is shrinking
What is the theory of the firm?
• neo-classical economic concept meant to explain why companies exist. Theory asserts that firms exist to achieve a single goal: maximizing owner wealth. This theory is appealing because:
◦ 1) fits with henry hansmanns understanding of firms as cooperative ventures. Why firms should maximize owner wealth,
◦ 2) having a single variable (wealth) to optimize makes the job of management a lot easier than to optimize multiple variables.
What is the agency problem? What is an example of this occurring?
• Managers defrauding the shareholders. When the shareholders act as principles and delegate that the task of managing the company to an executive team, the executives comes the agents. The fear is that the executives will act opportunistically.
◦ Opportunistic behaviour may take the form of passively shrinking their work or actively stealing from shareholders. Ex. Conrad black example
‣ Spending profits (that should have been paid to shareholders as dividends) on apartments, corporate jets and lavish parties
‣ Basic form of profit and loss statement: Revenues - Expenses = Net Income
• Net Income either stays in the company as retained earnings (only reason to do this it’s for reinvestment back into the company) or goes out to the company as dividends. Shareholders should benefit either way! Money paid out = benefits with present dividends or prudently reinvestment = future benefits in the future with higher dividends
‣ The point is that there were misaligned interests, information asymmetry and opportunism, and finally the “agency problem” where executives steal from the owners.
What are the three solutions mentioned for the agency problem?
• Board of Directors - elected by shareholders and job is to monitor (fire, hire, determine compensation) actions the executives. This reduces moral hazard risk (reduce information asymmetry)
◦ Why BoD may fail - inside directors (executives of a company may serve on its board, too many inside directors undermine the boards mission), outside directors (preferred to insiders by shareholder advocates, interlocking directorships undermine the boards mission)
• External Audits - performed by CPA firms, goals: 1) reporting to investors is standard and accurate, 2) good internal controls are in place, 3) managers and employees aren’t stealing from shareholders. Reduces information asymmetry
◦ Why external audits may fail - time and budget constraints, internal accountants may try to hide fraud, auditors follow fairly standard procedures, conflict of interest
• Performance-based compensation - executives receive stock options and cash bonuses based on profits the firm posts. This gives executives a reason not to steal from the firm - creating aligned interests.
◦ Why this may fail - may cause executives to focus on the short term, but wealth of shareholders is determined by long term prospects.
Explain the first position of the moral limits of the market.
Position #1: everything should be distributed by the market (libertarian views)
- market forces should operate without interference to reach “market clear”
- issues with waiting time for babies: the price is too low!
1) value of babies? Price sells at
2) price? Adoption fees
3) who determines these? Tightly regulated by gov
4) how does gov set these fees? Cover costs of having the child and evaluating the parents - issues that babies have preferred attributes. Argument is that desired babies should sell at a premium and undesired babies should sell at a discount◦ Possible Objections
‣ 1) Abuse - people who buy babies may do so to subject them to abuse or otherwise exploit them
• Reponse: laws forbidding child neglect and abuse would presumably apply fully to adoptive parents
‣ 2) The Rich would get the best babies
• Response: people with high incomes tend to have high opportunity costs for time, wealthy usually have smaller families than the poor.
‣ 3) Trafficking of human lives
• Response: have been undermined by the recent changes in public policy, is paying paying pregnant women o carry the child to term so offensive an alternative to abortion.
• Generalizing - pretty much anything can be allocated via the market, demand and supply will move towards equilibrium. The market will efficiently match those seeking to adopt with those waiting to be adopted.
Explain the second position of the moral limits of the market.
- many things are not allocated by the market: welfare benefits, voting rights, body organs. This view presents the idea that private property shouldn’t exist, making buying and selling of goods a meaningless concept.
1) Labour theory of value
- how does a product gain worth? Capital, raw materials (no one owns these) and labour.
- living labour (# of hours expended in the present)
- dead labour (# of hours expended in the past)
In short - everything should be reduce to a single metric, the number of hours involved in making it. So the product should belong to those who made it.
2) Internal labour
‣ The kind of labour that when performed is personally fulfilling to us, and so the desire to do it arises within us.
• ex. external labour (factory worker, fast food restaurant worker) done to earns wages, means to an end, the beneficiary is the capitalist, the labour belongs to the world of things
• ex. internal labour (craftsperson, small family farmer) done to express/realize our spirits, an end in itself, the beneficiary is the worker, the labour belongs to the world of people
• The wrong type of labour alienates us, the right type is fulfilling and meaningful to the person doing it.
• If society is structured more so that there is almost no mass production you would have people doing craftwork and small family farming, they are generally more fufilled.
• Could we have a society that simply produces simply give it away? A society without ownership and therefore without markets.
in summary no goods should be distributed through the market because 1) labour theory of value - goods belong to those who made them, 2) internal labour concept - if society were reconstructed and people did more meaningful work, people would produce to give away and we shouldn’t need a market.
Some objections: as commmunist countries have failed states - doesn’t it show it doesn’t work? Are there actually working examples of marxist societies? Aren’t people hardwired to be self-interested and to possess belongings?
Explain the third position of the moral limits of the market. (Part 1)
MOST THINGS SHOULD BE DISTRIBUTED VIA THE MARKET, BUT SOME THINGS SHOULD NOT BE - because they cause the market to fail…
Market is supposed to facilitate the exchange of commodities. Market success occurs when people are better off, resources directed to those who want it. (Market clearing price found and no extraordinary profits)
Market failure occurs when:
1) good are on backorder in LT
2) goods set idle over LT
3) extraordinary profits exist over LT
Types of failures:
1) When imperfect competition exists (monopolies)
2) when perfect comp exists by there are:
A) instabilities (weather/agriculture) remedied by government
B) positive externalities - benefits (non-excludable, non-rivalrous)
C) negative externalities - costly
‣ Ex. pollution solutions: 1) specially tax the manufacturer to pay for environmental clean up, 2) make the manufacturer buy technologies to reduce/eliminate the pollution. ‣ ex #2 - heroin - costs of addition paid by consumers and residents (policing due to driving under the influence, acute care, chronic care, treatment for infectious diseases spread, financial assistance, lost productivity). Possible solutions: legalize it and specialty tax or make manufacturers buy technologies? Not likely! **When externalized costs are too great to ever be recouped, sale of the product in the market must be prohibited.**
• Conclusion - some things should be disallowed from the market because they will cause the market to fail in its purpose. When a good is suitable for market distrbution, the market will arrive at a price such that all the costs of the good are recouped. (labour, RM, fianncing, and hidden costs to third parties)
Explain the third position of the moral limits of the market. (Part 2)
MOST THINGS SHOULD BE DISTRIBUTED VIA THE MARKET, BUT SOME THINGS SHOULD NOT BE - because they’re not commodites …
Key characteristics of commodities:
1) Alienable (Kant) - separate from owner
• inalienable things can’t be distributed, are inseparable to the human essence ex. prostitution, body parts
• Position: some things can’t be commodified because they’re inalienable
• justification: proprietor (subject) and property (object). A man cannot dispose of himself because he is not a thing.
• Objections: 1) it’s not uncommon to sell body for sex, 2) what about hiring labour?
2) Fungible (Radin) - not unique
• there is an element of non-fungibility in personhood, focus on babbies and prostitution
• Position: some things can’t be commodified because they;re non-fungible
• Justification: we shouldn’t take actions that dehumanize us, ultimately ends-in-ourselves
• Double-bind problem: while it may dehumanize us to reduce ourselves to commodities, it may also dehumanize us to not do so at times. “desparate exchanges” (poverty)
• Partial commodification (ex. labour or sexual services with limits)
◦ commodification: for sales ex. cars and toothbrushes
◦ partical commodification: for sale but regulated: ex. surrogacy, general labour, sexual services
◦ no commodification ex. children, child slavery
3) Commensurable (Anderson) - valued in dollars
• goods valued for non-utility (useful) reasons
• value to economists (utility) and to philosopher (utility, emotion, sharing, respect)
◦ commodity: something value only for its utility
◦ non-commodities: things valued for reasons in addition to or instead of utility
‣ ex. babies, park spaces, education shouldn’t be traded in an open market
◦ Why are economists so simplistic in their views? 1) they’re stupid, 2) they are purposeful in ignoring things and simplifying
