Week 1 papers

Question 1

Give a short summary of Jensen & Meckling (1992)

SPECIFIC AND GENERAL KNOWLEDGE, AND ORGANIZATIONAL STRUCTURE

Answer 1

Delegation is needed for efficiency (bring D to specific K) –> Delegation creates a control problem –> Cannot be solved with alienability (which markets can) –> Use internal rules and control systems.

Question 2

What characterizes specific and general knowledge

Jensen & Meckling (1992): SPECIFIC AND GENERAL KNOWLEDGE, AND ORGANIZATIONAL STRUCTURE

Answer 2

Specific knowledge is hard and expensive to transfer
General knowledge is inexpensive to transfer.

Question 3

What is the outcome of decentralization of decision rights if no agency problem exists?

Jensen & Meckling (1992): SPECIFIC AND GENERAL KNOWLEDGE, AND ORGANIZATIONAL STRUCTURE

Answer 3

If no agency problem exists, delegation of DR to persons with specific K leads to higher efficiency.

Question 4

Why are control systems required and what does it hope to achieve?

Jensen & Meckling (1992): SPECIFIC AND GENERAL KNOWLEDGE, AND ORGANIZATIONAL STRUCTURE

Answer 4

Decision makers have self interests, so delegation creates agency problems.

Control systems required to align agents’ behavior with firm’s goals.

Question 5

What is alienability?

Jensen & Meckling (1992): SPECIFIC AND GENERAL KNOWLEDGE, AND ORGANIZATIONAL STRUCTURE

Answer 5

The ability to transfer or sell decision rights to others (feature of capital markets, but not organizations).

Question 6

How do markets solve rights assignment and control problems?

Jensen & Meckling (1992): SPECIFIC AND GENERAL KNOWLEDGE, AND ORGANIZATIONAL STRUCTURE

Answer 6

Markets solve rights assignment and control problems by granting alienable rights to individuals.

Question 7

Lack of what causes organizations to need to use internal rules and control systems to manage decision-making?

Jensen & Meckling (1992): SPECIFIC AND GENERAL KNOWLEDGE, AND ORGANIZATIONAL STRUCTURE

Answer 7

Lack of alienability

Question 8

Where does the agency cost of equity come from?

Jensen & Meckling (1976): THEORY OF THE FIRM: MANAGERIAL BEHAVIOR, AGENCY COSTS AND OWNERSHIP STRUCTURE

Answer 8

from delegation of decision rights from shareholders to CEO. He has limited equity, so he is not fully confronted with costs of perks. (Moral hazard)

Question 9

What are costs of equity the sum of?

Jensen & Meckling (1976): THEORY OF THE FIRM: MANAGERIAL BEHAVIOR, AGENCY COSTS AND OWNERSHIP STRUCTURE

Answer 9

• Monitoring costs by the principal
• Bonding costs by the agent
• Residual loss

Question 10

Who bears the entire effects of consuming perks and how?

Jensen & Meckling (1976): THEORY OF THE FIRM: MANAGERIAL BEHAVIOR, AGENCY COSTS AND OWNERSHIP STRUCTURE

Answer 10

Managers bear the entire wealth effects of consumption of perks as long as the equity market anticipates these effects.

Prospective shareholders realize interests diverge –> impound monitoring + residual into the price they are willing to pay for shares.

Question 11

What are the agency costs of debt?

Jensen & Meckling (1976): THEORY OF THE FIRM: MANAGERIAL BEHAVIOR, AGENCY COSTS AND OWNERSHIP STRUCTURE

Answer 11

They use debt covenants

• Constraints on managerial actions
• Bankruptcy and reorganization costs.
• Costs of writing and enforcing covenants

Costs are incorporated in CoD

Question 12

What is the inherent problem with debt financing?

Jensen & Meckling (1976): THEORY OF THE FIRM: MANAGERIAL BEHAVIOR, AGENCY COSTS AND OWNERSHIP STRUCTURE

Answer 12

Asymmetric payoff function of equity investor.

Question 13

Why are a control system and DSM (PM for divisions) required for BUs?

Abernethy et al. (2004): Determinants of Control System Design in Divisionalized Firms

Answer 13

Control system is needed to align managers’ action with corporate goals (with decentralization), even while they operate independently. DSM (PM) are used to mitigate control problems.

Question 14

When does the use of DSM (PM) increase and decrease?

Abernethy et al. (2004): Determinants of Control System Design in Divisionalized Firms

Answer 14

Increase: More decentralization
Decrease: More interdependencies

Question 15

What is the result of greater information asymmetry

Abernethy et al. (2004): Determinants of Control System Design in Divisionalized Firms

Answer 15

More information asymmetry between BU and CEO leads to more decentralization

Question 16

What is the result of more decentralization on DSM (PM)?

Abernethy et al. (2004): Determinants of Control System Design in Divisionalized Firms

Answer 16

When more decentralization, a greater weight is placed on DSM (PM) of performance.

Question 17

In what context are personnel controls important to solve incentive alignment problem created by decentralization?

Campbell (2012): Employee selection as a control system

Answer 17

When it is difficult to determine if employees use decentralization effectively via measuring and contracting output (output controls)

Question 18

Why does the new system with more decentralization make more use of selection of employees with particular attributes?

Campbell (2012): Employee selection as a control system

Answer 18

Because it is harder to use standard PMs to solve alignment problems.

Question 19

What are the advantages and disadvantages of centralized hiring?

Deller & Sandino (2020): Who Should Select New Employees, Headquarters or the Unit Manager? Consequences of Centralizing Hiring at a Retail Chain

Answer 19

Centralized hiring: consistently align employees with company values / corporate goals, but can neglect BU managers’ local knowledge

Question 20

What are the advantages and disadvantages of centralized hiring?

Deller & Sandino (2020): Who Should Select New Employees, Headquarters or the Unit Manager? Consequences of Centralizing Hiring at a Retail Chain

Answer 20

Decentralized hiring: exploit superior information of local manager in hiring decision (know more about local market and fit), but are less good at aligning employees with corporate goals.

Question 21

When does centralized and when does decentralized lead to better hiring results?

Deller & Sandino (2020): Who Should Select New Employees, Headquarters or the Unit Manager? Consequences of Centralizing Hiring at a Retail Chain

Answer 21

If manager has more knowledge about local situation, centralized better

Question 22

What are the primary goals of controls?

Sandino (2007):Introducing the First Management Control Systems (MCS): Evidence from the Retail Sector

Answer 22

• Minimize cost
• Enhance revenue
• Minimize risk
• Basic controls

Question 23

What correlation exists between control and strategy?

Sandino (2007): Introducing the First Management Control Systems (MCS): Evidence from the Retail Sector

Answer 23

Firm with differentiation strategy more often use revenue control

Question 24

What is the result for the fit between strategy and control?

Sandino (2007): Introducing the First Management Control Systems (MCS): Evidence from the Retail Sector

Answer 24

Firms that use differentiation strategies and revenue controls that have a fit, perform better.

Better fit, better results

Question 25

What are arguments for and against contingency theory?

Answer 25

For: differentiation strategy use more revenue controls, and better results when fit.
Against: there are basic controls every firm has.