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I&C > Week 1 slides > Flashcards

Week 1 slides Flashcards

1
Q

What is the basic assumption of economic models?

A

The basic assumption of economic models is that people are motivated by financial incentives

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2
Q

What are the 2 basic assumptions of economic models?

A
  1. Greed: people prefer more over less - utility increases with each additional unit
  2. Risk-aversion: utility increases at decreasing rate with each additional unit
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3
Q

In what form can the 2 basic assumptions be seen? Also provide an example

A

A concave
Rather more than less, but decreasing increase.
Loss 2k to 1k is bigger than gain from 2k to 3k.

The utility gain is smaller.

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4
Q

What is another assumption of economic models?

A

Information asymmetry (private information)

The models are split by the actions/effort of what has been done and the characteristics of the information.

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5
Q

What are the 3 asymmetric information models?

A

Moral Hazard (!!)
Screening/adverse selection
Signaling

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6
Q

Describe the characteristics of moral hazard

A
  • Agent has private information about their own actions
  • Misalignment of interests between principal and agent (agent prefers leisure of effort)
  • Principal elicits high effort and desired actions by offering contracts with performance bonus as reward for productive effort –> incentive compensation contracts.
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7
Q

Describe how the process relating to moral hazard works

A

Agent and principal have misaligned interests. Uninformed party (principal) moves first with incentive compensation contract. This gives principal a PM to judge agent –> problem limited since the agent is motivated.

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8
Q

What is moral hazard?

A

One party (agent) takes risks because the cost of consequences of those risks will not be fully borne by them, but by the principal.

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9
Q

What are the characteristics about screening?

A

Focus is on characteristics, not actions
- Agent has private information about characteristics
- Principal induces agent to reveal their private information about its type by offering contracts beneficial to high type, but not for low type.

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10
Q

How does screening effectively work?

A

The agent gives away a part of his private information by accepting such a contract. People with ‘undesired’ characteristics will be less likely to accept the contract.

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11
Q

What are examples of screening?

A
  • Health insurer with higher premium and coverage so only certain people self-select into those plans
  • Firm with strong incentive pay, only certain people self-select into those firms.
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12
Q

What are the characteristics of signalling?

A

Informed party moves first
- Agents communicate their type to principal by taking actions less costly to the high type.
- you communicate your characteristics with a strategy that low type can’t copy.

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13
Q

What are examples of signalling?

A
  • Education (more costly for low type, so credible way to communicate ability for high type)
  • Product warranty
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14
Q

What is the definition of signalling?

A

Agents take actions to credibly communicate their type to the principal.

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15
Q

What 2 things are many organizations characterized by?

A
  • Asymmetric information (some members have informational advantage)
  • Misaligned objectives (some people have different personal objectives than the corporate objective).
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16
Q

What caused the Wells Fargo problems?

A

Moral Hazard

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17
Q

Knowledge is valuable in decision making, so what must happen?

A

Bring (co-locate) decision rights and important knowledge for these decisions together.

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18
Q

What are the 2 alternatives to bring decisions rights and knowledge together (caused by dispersion of knowledge throughout organization)

A
  1. KTC: move knowledge to decision rights
  2. CC: move decision rights to those with knowledge
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19
Q

What 2 problems are created with the decentralization of decision rights?

A

Rights assignment problem: where to place decision rights?
Contro/agency problem: how to make sure decision rights are not used for personal gain but for corporate objectives.

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20
Q

What is the result of alienable rights not being applicable in firms?

A

No alienability of rights, so assign decision rights to lower-level employees with specific knowledge valuable for decision making.

Rely on internal delegation, offer rewards & punishments.

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21
Q

What is alienability?

A

The ability to sell or transfer ownership of assets or decision-making rights, and to pocket the proceeds from such transactions.

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22
Q

What is the agency problem?

A

Decentralized decision-makers might prioritize their own goals over the organization’s objectives.

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23
Q

What does completely centralized result in?

A

Low costs inconsistent objectives & high costs poor information

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24
Q

What does completely decentralized result in?

A

High cost inconsistent objectives & low cost poor information

25
Q

What are PM used for in the level of delegation context?

A

You use PM to judge if people with decision rights handle in line with corporate objectives.

26
Q

What trade-off determines the optimal level of delegation?

A

Cost of poor information vs Cost of inconsistent objectives.

27
Q

What is the bottom-line of why I&C problems emerge?

A

Partition decision-making rights throughout organization.
Create incentive system that:
- Provides measures of performance
- Specifies relationship between rewards and punishments and PM outcomes.

28
Q

What 3 different controls does the system of Framework of Merchant & Van Der Stede differentiate?

A

Result controls: focus on result of your actions, define PM –> rewards & punish behavior
Action controls: focus on behavior, which actions are allowed and which not
Personnel and cultural controls: focus on personal norms and norms or organization

29
Q

What are the 2 design choices in the framework of Merchant & Van Der Stede?

A

Which combination to use & how tight should each control be?

30
Q

What control should be used in the situation with low knowledge about desirable actions and low ability to measure results on important performance dimensions?

A

Personnel and cultural controls

31
Q

What do you do with result controls and where are result control particularly important?

A

Hold employees accountable for delivered results (reward/punish outcomes).
Result controls especially important with asymmetric information.

32
Q

How do result controls facilitate empowerment?

A

If actions are not constrained. Employee can select actions they believe best. Use of summary PM creates autonomy for lower-level employees.

33
Q

What is not allowed regarding PM in result controls?

A

Results must not be susceptible to manipulation.

34
Q

What is the controllability principle? Related to result controls.

A

Employee who is held accountable must be able to influence the results in a material way.

35
Q

What does the use of result controls imply?

A

Result control imply ex-post use of PM.

36
Q

What does rewards and punishments tied to results imply?

A

If rewards and punishment are tied to result, this implies use of PM in an ex-ante fashion.

37
Q

What is the consequence if PM is affected by external factors?

A

Employee is exposed to risk. He might take appropriate decisions but is not rewarded. Employees demand risk premium, so PM-based compensation contract more costly for firm.

38
Q

What are action controls?

A

Focus on guiding employee behavior and ensuring that specific actions align with organizational goals.

39
Q

What are the two assumptions of action control?

A
  • Observability: decision/actions are observable to superior manager
  • Knowledge of desirable actions: superior level knows which actions are desirable.
40
Q

What are 4 examples of action controls?

A
  • Direct supervision
  • Behavioral and administrative constraint
  • Action accountability
  • Pre-action review
41
Q

What are the advantages of action controls?

A

Codification of best practises, coordination incorporated in procedures

42
Q

What are the potential disadvantages of action controls?

A

Means-end inversions, deters creativity and innovation.

43
Q

What are personnel controls?

A

Focus on harnessing employees’ intrinsic motivation and aligning their natural preferences with organization objectives.

Builds on self-control, intrinsic motivation, ethics, etc.

44
Q

What 3 items are related to implementing personnel controls

A
  • Selection and placement
  • Training
  • Job design and provision of resources.
45
Q

What are cultural contols?

A

Refers to shared norms and values, and social pressure exerted by groups on individuals (mutual monitoring)

46
Q

Why are personnel and cultural controls often called soft controls?

A

Because they focus on influencing behavior through intrinsic motivation, social norms, and shared values rather than through strict rules and oversight.

47
Q

What are 5 ways to reinforce cultural controls?

A
  • Codes of conduct (beliefs and boundary system)
  • Group-based rewards
  • Intra-organizational transfers
  • Physical and social arrangements
  • Tone at the top.
48
Q

What are the 2 I&C problems that exist in corporate boards?

A
  • Presence of asymmetric information
  • Imperfect alignment of interests
49
Q

What does separation of ownership and control introduce?

A

Agency problems (moral hazard)

50
Q

What are the 3 agency costs of equity?

A
  • Monitoring costs of the principal
  • Bonding costs by the agent
  • Residual loss
51
Q

What are the 3 agency costs of debt?

A
  • Incentive effects associated with high leverage
  • Monitoring costs that follow from incentive effects
  • Bankruptcy costs
52
Q

What is the result of high leverage in firms?

A
  • owner has incentive to adopt riskier projects (asymmetric pay-of function)
  • Creditors anticipate and take into cost of debt.
53
Q

What do lenders do to restrict management actions?

A

debt covenants, restrict management actions, but they are not complete.
Costs of writing, enforcing and residual impounded in CoD.

54
Q

What are the benefits of I&C systems?

A

Higher likelihood organizational objectives and strategies will be accomplished.

55
Q

What are the costs of I&C systems?

A
  • Direct costs: monetary (bonusses paid) and time & resources: time allocated to execution of I&C, time devoted to revising I&C
  • Indirect costs: costs associated with harmful side-effects.
56
Q

What is typically most cost-efficient?

A

Accept probability of divergent behavior of employees (residual loss)

57
Q

What is contingency theory?

A

No universally best I&C system that applies to all situations and organizations.

58
Q

What is the alternative to contingency theory?

A

One size fits all.

I&C (12 decks)

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