Hierarchies, incentives and firm structure ECOS3003
Tutorial 2
1. Is it worthwhile for shareholders to seek to completely eliminate incentive problems with managers and directors through means such as monitoring? Why or why not?
2. How does concerns about reputation aid in the enforcement of contracts?
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3. Consider a model with one worker who works for one boss. In each period the worker can work
hard or not work at all. If the worker works hard she will create $8 worth of profit. The boss can then decide how to share this profit with the worker (that is, how much of the $8 the worker gets). If the worker does not work she creates $0 profit. There are an infinite number of periods and both parties discount future payoffs by ¦Ä.
There is a social convention that the worker will work hard if in every previous period the boss gave the worker half of the profit. If this is not the case the worker will not work again in any future periods. What is the ¦Ä required to sustain this social convention as an equilibrium?
Interpret this social convention as an implicit contract.
4. What is a firm¡¯s organisation architecture?
5. What is the architecture of markets?
6. The Australian Competition and Consumer Commission recommends changes in the way anti-
competitive law should analyse mergers. Among other things, the recommendations would likely make it easier to justify mergers on the grounds that it reduces costs or increases competition. The idea is that some mergers between competitors result in significant cost savings, enhance competition and result in lower prices. Would these recommendations affect organization architecture if adopted? Explain the connection.
7. Which of the following will affect the design of the optimal architecture?
a. market conditions
b. regulation
c. technology
d. all of the above
e. none of the above
8. Bob is the owner of a chain of tyre stores in Melbourne and Sydney. Bob makes the pricing a stock decisions for all of the Sydney outlets, but allows each of the Melbourne store managers to make their won pricing and stock decisions. How will this change affect the other aspects of the firm¡¯s architecture?
ECOS 3003 Tutorial 2 1
9. Sharon wants to buy a widget but she knows that 20 per cent of the people she has to deal with are dishonest. If she deals with a dishonest person she gets $0 benefit. If she deals with an honest person she gets $20 benefit from the trade. To Sharon, dishonest and honest people look alike ex ante.
a. Sharon is matched with a potential trader. Will she be willing to trade?
If the potential trading partner is honest he will all make a fair deal and Sharon will receive $20 benefit. The honest person will get $10. A dishonest person however can choose to be honest or dishonest. If he is honest the benefits to Sharon and to himself are $20 and $10; if he is dishonest Sharon gets $0 and the trader gets $25 benefit. There are two periods in which trade can occur.
b. In the last period, if trade in the first period was ¡®honest¡¯, will Sharon trade again?
c. Now consider the first period. Will an dishonest trader act dishonestly or honestly in the first
d. Now trade can occur potentially an infinite number of times. Sharon adopts a trigger-strategy if trade is ever dishonest. Both parties have a discount factor of ¦Ä. When will the dishonest trader act honestly?
10. What factors encourage a trading party to take another on trust, rather than enforce ¡®good¡¯ behaviour with a contract?
ECOS 3003 Tutorial 2 2
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