The Firm Flashcards
Principal Agent problem and disciplines
This concerns strategic interactions.
“A principal who wants an agent to act in the principal’s interests but who possesses less information that the agent”
Managers are subject to financial constraints and tend to be risk averse. The optimal contract between shareholders and managers is one that balances the benefits from insuring the manager against risk, on the one hand and the benefits from providing the manager with the right incentives on the other. However this is hard to solve.
This all relates to the internal discipline of the firm = the need to align stakeholder interests.
Labour market discipline = managers desire to have a good reputation that provides them with good incentives.
Product market discipline =product market competition serves to align shareholders’ and managers objectives. The idea being that under intense competition the firm has to maximise profits to survive.
Capital market discipline: if a manager does not PM then the value of the firm is lower than its potential. Therefore a raider could acquire the firm, change management to maximise profits and thus make a capital gain.
To summarise: although management and ownership are normally separated, there are reasons to believe that deviations from profit maximisation cannot be too large. These reasons include management incentive contracts and the disciplines mentioned.
Specific assets and vertical boundaries
Firms have to decide whether to make or buy inputs. I.e to use the market (vertically separate) or use the firm (vertically integrate).
The key elements of the theory are the occurrence of specific assets (Assets which are designed for one purpose) and the resulting possibility of opportunistic behaviour once those investments are made (a situation known as hold-up problems.
The extremes of vertical integration and separation imply incentive problems. Sometimes the solution lies between both: tapered integration (where a given input is bought from an affiliated supplier and an integrated one and franchising.
The horizontal boundaries of the firm are largely determined by cost considerations. The vertical boundaries result from the balance between investment incentives (specific assets) and performance incentives.
Why are firms different?
There may be reasons why firms are different or possess s sustainable competitive advantage:
1) Impediments to imitation
2) Causal ambiguity: where the features of an organisation are tacit knowledge, capabilities developed by experience and rarely written down and difficult to express formerly. So if a company recruits a manager, that manager would have trouble expressing their knowledge in the new organisation, let alone implementing it.
3) Strategy
4) History
5) Culture (firm culture)
In summary:
Firm performance varies. They are different because of impediments to imitation, causal ambiguity and historical events.
