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econ 308


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5 basic organizational architecture questions
1. How to assign decision rights within the firm? 2. How to bundle tasks into jobs and jobs into business units? 3. How to recruit and retain members of the firm for specific jobs? 4. How to reward and share risk with members of the firm? 5. How to design a system to evaluate objectively and /or subjectively the performance of members and business units of the firm?
5 basic managerial economic questions
1. What is the optimality condition of promotion spending for a revenue center? 2. What is the cost minimizing input mix for a cost center? 3. What is the profit maximizing output mix for a profit center? 4. What is the optimality condition of diversification for an investment center? 5. What is a winning strategy of a business game?
3 implications of economic darwinism
1. successful firms in an industry are not random. 2. firms’ success is relative and not absolute. 3. to remain successful a firm must adapt to new technology, competition, or regulation change. The three economic Darwinism managerial implications suggest that even though there can be changes to improve architecture that a manager should do careful analysis instead of just going through with the first idea in their head. Executives need to see the overall plan and its alternatives and also see how specific organizations would work in these particular plans and alternatives as for examples. These executives should also look at claim benefits of changing organization structure when organization has been stable.
basic economic principles
1. people are non-satiated, self interest and smart. 2. resources are limited. 3. prices economixe on the cost of transferri ng intormation to coordinate decisions. 4. people do tradeoff, e.g monetary and nono-monetary rewards are both important. 5. people react to incentive. 6. information is costly and there is imperfect, asym,metric and incomplete information leading to adverse selection and moral hazard. 7 people are risk adverse; certainty equivalence and risk premium 8 Diversify but don’t diversify for the sake of diversification. 9. marginal analysis 10 opportunity cost is the relevant cost 11. free rider problem 12. rent-seeking behaviour 13. Coase Theorem, property rights and Common Pool Problem 14 three elements of decision theory and fce elements of game theory 15 fairness; efficiency versus equity
specific knowledge and general knowledge
Specific Knowledge: is expensive to transfer e.g idiosyncativ knowledge of particular circumstances, scientific knowledge and knowledge from learning –by- doing. -General Knowledge is free to transefer. (firms are constantly taking ideas and specific knowledge of their employees that are their “wetware” –ideas- and converting them into general knowledge that is “software”-instructions and formulas- that can be employed to produce products and services. -specific knowledge is used to denote knowledge that is relatively high on its scale. Examples of general knowledge are prices and quanitities –a storekeeper easily can tell you that the price of sugar is $1 per pound.
various forms of transaction costs
Transactions costs; including search, information. Bargaining, decision, monitoring and enforcement costs. (the optimal method of organizing an economic transatioc is the one that minimizes transaction costs. - Cost associated with exchange of goods or services and incurred in overcoming market imperfections. Transaction costs cover a wide range: communication charges, legal fees, informational cost of finding the price, quality, and durability, etc., and may also include transportation costs. Transaction costs are a critical factor in deciding whether to make a product or buy it.
define a firm
Firm is a focal point of a set of implicit and explicit contacts. -a contract is an agreement to facilitate deffered exchange. -implicit contracts are not enforceable in a court of law but legal contracts are. - a partnership or association for carrying on a business.
5 reasons why firms exist
Firms exist-to minimize transacton costs and to achieve information specialization -to enjoy economies of scale and scope -to diversify risk -To solve problems of specific assets -to pose bond to trading partners through reputation (specific assets are assets that are woth more in their current use than in alternative uses. - Firms or organisations exist as an alternative system to the market mechanism when it is more efficient to produce in a non-price environment.
seperation of ownership an d management
The separation of ownership and control refers to the phenomenon associatedwith publicly held business corporations in which the shareholders (the residualclaimants) possess little or no direct control over management decisions. Thisseparation is generally attributed to collective action problems associated withdispersed share ownership. The separation of ownership and control permitshierarchical decision making which, for some types of decisions, is superior tothe market. The separation of ownership and control creates costs due toadverse selection and moral hazard. These costs are potentially mitigated by anumber of mechanisms including business failure, the market for corporatecontrol, the enforcement of fiduciary duties, corporate governance oversight,managerial financial incentives and institutional shareholder activism.
principal agent problem
principal agent problem involves a principal who wants an agent to exert effort to benefit the principal, and how the principal design incentive and risk sharing compensation to induce the agent to exert an optimal level of effort. In political science and economics, the principal-agent problem or agency dilemma treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent. Various mechanisms may be used to try to align the interests of the agent with those of the principal, such as piece rates/commissions, profit sharing, efficiency wages, performance measurement (including financial statements), the agent posting a bond, or fear of firing. The principal-agent problem is found in most employer/employee relationships
7 sources of conflict between owners and managers
efforts are costly to managers but increase the value of a firm -once compensation package is given to managers, they try to increase prequisties which are costly to a firm but tax-free to the managers. - Managers typically have substantial human and financial capital invested in the firm that they might be excessively risk averse. - Managers with large contolling ownership interests in a firm might involve with self- dealing to enrich themselves at the expense of the general sharholders. -horizon pro blem: managers’ tenure with a firm has a finite horizon but a firm presumably has an infinite horizon. - managers bear personal cost of decision-making but not the firm leading to voersizing. -Members of a firm are grouped to form teams leading to free rider problem.
conflict of sharholders and bondholders
Shareholders might enrich themselves at the expense of bondholders and vice versa. - Conservative accounting reduces the earnings and retained earnings amounts used in debt contracts to constrain dividends. Thus, choosing more conservative accounting is one way the firm can reduce the risk to bondholders that it will pay excessive dividends to shareholders. In particular, overpayment of dividends can transfer wealth from bondholders to shareholders by reducing the assets available for meeting bondholders' fixed claims and hence increasing the default risk for bondholders.
conflict of large and small shareholders
Large shareholders might enrich themselves at the expense of small shareholders.  - Large shareholders have a dual impact on firms (Shleifer and Vishny, 1997) ⬢ Strong incentive to monitor management ⬢ Extract rents, enjoy private benefits of control
4 costs of contracts
Costs of contracts; legal costs for writing, interpreting, monitoring and enforcing contracts -information cost and contingencies -uncertainty and incomplete contracts -contract renegotiation. Costs of contracts; legal costs for writing, interpreting, monitoring and enforcing contracts -information cost and contingencies -uncertainty and incomplete contracts -contract renegotiation.
2 pre contracting information problems and their solutions.
Pre-contracting informational asymmetries can cause bargaining failure –e.g strikes- and adverse selection. 1. Bargaining failure solution- 2. Solutions to adverse selection-reduce or remove information asymmetry -introduce deductibles and co-payments -introduce variety of contracts to sort out trading partners with different private information. -allow trading partners to signal their private information
4 post contract problems and their solutions
Post contract problems- agency (moral hazard)( problems (one solution is bonding) -informaiton cost e.g monitoring cost -enforcement cost -legal cost of recourse
when will reputation concerns in implicit contracts more likely to be effective?
If the gain from cheating is small -the likelihood of detecting cheating is high -the expected sanction imposed if cheating is detected is high.
3 imporant aspects of organizational architecture of a firm
the assignment of decision rights within the firm (administractive decisions versusu transfer prices) and an information system to transfer the right info to the right person. -the design of reward system of members of the firm to control incentive conflicts -the designh of performance evaluation system of members and business units of the firm to monitor and control
primary goal of an economic organization?
The primary goal of an economic organization is to produce and sell to consumers what they want at the lowest possible cost.The challenge is how to get the relevant information from so many different memebers of the firm to the right person to make the right decisions and to provide the incentive for the right person to use the information productively. Organizational change should be undertaken only if expected marginal benefit exceeds expeced marignal cost.
3 costs of changing organizational architecture
direct cost -indirect costs -incenitives
Corporate culture
corporate culture - philosophy, values, behavior, dress codes, etc., that together constitute the unique style and policies of a company. -it is the passing of practices from one generation of owner and employees to those in the next generation such as the way jobs are assigned , decision rights are assigned, the way members of the firm are rewarded and controlled, and organizational features such as customs, taboos, company slogans, heros, public recognition andn social rituals.
2 dimensions of a job
two dimensions of a job- varitety of tasks to be completed -decision authority to determine when and how to best complete the tasks
when are decisions made at the top?
. decisions are made at the top management level –if firms are small, -if market shares of firms are stable.
when are decisions decentralized?
decisions are decentralized –if firms are large - if market shares of firms experience rapid changes in business environment, new product and or market expansion and introduction of new product varieties
5 benefits of decision decentralization
. benefits of decision decentralization- effective use of local knowledge -conserve top management time wile reduce middle management -attract talents to junior management positions in business nits to prunefor future senior management positions in corporate headquarters - successful use of local knowledge in one business unit might be transfer to other business units leading to new process and or new products -reduce rent-seeking costs within the firm
3 costs of decision decentralization
cost of decision dencetralization – incentive conflicts increase as decision rights are delegated to lower llevel of the firm - coordination coss and failure e.g airline hub and spoke organization -less effective use of central information
why middle management is reducing in size and what is the new role of middle management?
lowering information cost eliminates middle management for controlling information flow. new roles of middle management include identifying and assembling a team, helping subordinates to design winning strategies, and providing motivation to members of the firm.
2 benefits (costs) of team decision making?
Two benefits of team decision making – improve us of disperse specific knowledge - broaden the support base among employees for changes
2 determinants of team size
Two determinants – purpose of the team - complexity of the problem
4 reasons for firms to form teams?
1 to manage a project 2to design and make a new product 3 to study a problem and to recommend actions 4 to transfer wealth among team members

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