Session 6: Internal Organization I

Question 1

JENSEN & MECKLING (1995): Focus of paper + organizational structure definition

Answer 1

The paper deals with different types of knowledge in organizations.

Organizational structure: Emerges when decision rights are delegated

Question 2

JENSEN & MECKLING (1995): Decision rights

Answer 2

When knowledge is valuable in decision-making, there are benefits to collocating decision authority with the knowledge that is valuable in making those decisions. There are two basic ways to accomplish such a collocation of knowledge and decision rights:
1. Moving the knowledge to those with the decision rights
2. Moving the decision rights to those with the knowledge

Question 3

JENSEN & MECKLING (1995): Centralized vs. decentralized

Answer 3

Centralized:
- Many hierarchial layers need to look at the idea (“fine-grained filter)
- Centralized firms are good at rejecting projects - but will also reject more good projects
- Decision quality (avoiding errors): When you must avoid the error of accepting bad projects. E.g., medecial approval authorities

Decentralized:
- Few (“coarse-grained filter)
- Decentralized firms are good at accepting projects - but will also accept more bad projects
- “Decision quality (avoiding errors): When you must avoid the error of rejecting good projects. Firms in industries with hefty competition and a strong emphasis on innovation: “The real sin is if we miss something”

Question 4

JENSEN & MECKLING (1995): Types of knowledge

Answer 4

Specific knowledge: Knowledge that is costly to transfer among agents. Because specific knowledge is costly to transfer, getting it used in decision-making requires decentralizing many decision rights in both the economy and in firms

General knowledge: Is knowledge that is inexpensive to transmit.

Question 5

JENSEN & MECKLING (1995): Rights assignment problem and control problem

Answer 5

Such delegation of rights in turn creates two problems:
* The rights assignment problem: Determining who should exercise a decision right
* The control or agency problem: Ensuring that self-interested decision agents exercise their rights in a way that contributes to the organizational objective

Question 6

JENSEN & MECKLING (1995): Alienable rights and why it does not work in firms

Answer 6

Alienable: Alienability is the effective combination of two rights: the right to sell or transfer rights and the right to capture the proceeds of exchange.

Alienability in firms: As we know them would not exist if alienability of all decision rights were granted to each agent along with the rights. Alienable rights cannot generally solve the control problem inside firms because firms cannot generally assign alienability along with the decision rights without turning each individual agent into an independent firm

Question 7

JENSEN & MECKLING (1995): Dealing with decision rights in the modern corporation

Answer 7

In organizations, assigning decision rights requires consideration of the costs of generating and transferring knowledge in the organization, and how the assignment of decision rights affects incentives to acquire information.

Question 8

JENSEN & MECKLING (1995): The optimal level of decentralization

Answer 8

Determining the optimal level of decentralization
requires balancing the costs of bad decisions due to poor information and those due to inconsistent objectives

(see picture in notes).

information plus the costs of poor decisions made because it is too expensive to acquire all relevant information. These falls as the CEO delegates decision rights to lower levels
* The costs owing to inconsistent objectives increase monotonically and at an increasing rate as the right is assigned to lower levels
* The optimal point: Occurs where the decrease in the cost owing to poor information just offsets the increase in the cost owing to inconsistent objectives (the point where the absolute values of the slopes of the two curves are equal).

Question 9

JENSEN & MECKLING (1995): Why delegate? Benefits and costs

Answer 9

Much knowledge is “local” and “tacit”; Cannot be centralized or at least only at a high cost
* Collocation: Making optimal use of such knowledge requires that it is matched with those who can make best use of it and they are allowed to act on it, i.e., collocation delegation

Benefits of delegation:
- Economizing with managerial time
- Speedy decision making
- Motivation
- Utilizing

Costs of delegation:
- Agency costs
- Evaluation mistakes
- Costs of coordinating interdependent activities in the face of change

Question 10

JENSEN & MECKLING (1995): Factors impacting the optimal degree of decentralization

Answer 10

1. Firm size: As the size of a firm increases, the sum of the cost owing to poor information and the cost owing to inconsistent objectives rises.
2. Changes in information technology have an ambiguous effect on the optimal degree of decentralization
3. Increased governmental regulation tends to increase centralization (Increase knowledge in HQ of dealing with regulatory agency)

Question 11

JENSEN & MECKLING (1995): Types of decision rights

Answer 11

Decision management rights are the rights to initiate and implement recommendations for resource allocations

Decision control rights are the rights to ratify initiatives and to monitor the implementation of resource commitments

Question 12

JENSEN & MECKLING (1995): The control system

Answer 12

Because all individuals in a firm are self-interested, simply delegating decision rights to them and dictating the objective function each is to maximize is not sufficient to accomplish the objective. A control system that ties performance is required. The control system specifies
1. Evaluation: The performance measurement and evaluation system for each subdivision of the firm and each decision agent
2. Reward/punishment: The reward and punishment system that relates individuals’ rewards to their performance

Question 13

FOSS (2003): Focus of paper

Answer 13

Many firms radically change the way in which they structure their boundaries as well as their internal organization. They arguably do this to foster the dynamic capabilities that are necessary for in the emerging knowledge economy

Question 14

FOSS (2003): Two types of hybrid organizational forms

Answer 14

External hybrids: Market exchanges infused with elements of hierarchical control

Internal hybrids: Hierarchical forms infused with elements of market control

Incentive costs: Internal hybrids are affected by distinct incentive costs that external hybrids tend to avoid, and that this may explain why external hybrids are chosen over internal hybrids

Question 15

FOSS (2003): The Oticon Case

Answer 15

Oticon (now William Demant) became world famous for its radical delegation experiment. The “spaghetti organization,” as it came to be called, was explicitly conceived of by its designers as an attempt to infuse the Oticon organization with strong elements of market control and was seen as a hard-to-replicate source of knowledge-based competitive advantage.

Question 16

FOSS (2003): The history of the Oticon case

Answer 16

Problems faced by Oticon: Industry leadership position lost, declining innovativeness. Declining market share, profitability

Solution: Hires a new CEO. He quickly engages in massive cost-cutting and centralizes all decision-power in his hands. He improved the situation but not enough (problem is declining innovativeness)

Solving innovation issue: Lars Kolind came up with a new organizational structure, which was intended to supplant what he called old Oticon.

(See picture in notes for the different oganizational forms for Oticon during the years)

Question 17

FOSS (2003): Spaghetti organization

Answer 17

Should be able to change rapidly, yet still possess coherence.
* Knowledge-based –> that is, consisting of “knowledge centers connected by a multitude of links in a nonhierarchical structure”.
* Anthropocentric –> Designing jobs so that these would fit the individual person’s capabilities and needs”; Provide the motivational support for this knowledge network.
* Free market forces –> Make it capable of actually combining and recombining skills in a flexible manner, where skills and other resources would move to those (new) uses where they were most highly valued.

Question 18

FOSS (2003): Why abandonment?

Answer 18

Seems strange because there was no change internally or externally that could motivate the change and everything had seemed to go right. There were three issues:
1. Design problem: Relations to top-management became very important (“rent-seeking”). Linking pay to team and individual performance may have harmed knowledge sharing –> Knowledge sharing behavior not part of the performance-measurement system
2. Management intervention: Despite the delegation, in reality, there was a lot of management intervention in the projects, which clashed with the values and demotivated employees
3. Incentive problems: Top managers may delegate rights, however, they can still overrule subordinates and may do that if they feel like they have superior information –> Harming motivation of project members (would not happen in markets, because parties are legally distinct).

Question 19

FOSS (2003): Lessons learned from the spaghetti

Answer 19

1. Radical delegation can revitalize an organization by mobilizing benefits of delegation—improved motivation, more creativity, better utilization of local knowledge.
2. However, also many coordination and cooperation problems
3. Eventually, costs overwhelmed benefits, causing the change to a more structure matrix org.
4. Firms are not markets: Even highly decentralized firms are characterized by the use of authority
5. Delegated rights are “loaned, not owned.”