Hierarchies, incentives and firm structure ECOS3003
Tutorial 4
1. Describe ways a boss can credibly make a commitment not to meddle too much in the decision making of a worker. Why would a boss ever want to make such a commitment?
2. A principal can either legally make a decision herself (P-formal authority) or can decide to assign the formal right to make a decision to her subordinate (delegation). In each case the party that has the formal right to decide can make a decision on a new project. If that party is uninformed they will defer the decision to the other party who will decide if they are informed. The principal’s effort level of finding a new project is denoted by E; e denotes the subordinate’s effort level. E and e represent the probability that both the principal and the agent discover a new project. The following table provides the effort levels of both parties under P-formal authority and delegation.
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P-formal authority Principal E = 0.7
Agent e = 0.3
If the principal’s preferred project is chosen, the principal gets a revenue/benefit of $100. Finally, the
probability that the agent’s preferred project is also preferred by the principal is α = 0.9. Considering the above example, which statement is true?
a. Delegation of authority maximises the expected revenue of the principal (not considering any costs of ex ante effort)
b. P-formal authority maximises the expected revenue of the principal (not considering any costs of ex ante effort)
c. The principal is less likely to delegate authority as α increases. d. The decision will be decentralised until MB = MC.
e. None of the above
4. Following Aghion and Tirole (or the lecture), write the equations for the principal and the agent when for P-formal authority. Solve the equations for E and e. Now write down the equations for the utility functions for each party respectively when the agent has formal authority. Explain how you get these equations and solve. When is the principal’s effort level higher? What is the intuition for this result? Under what authority regime does the agent put in more effort and why?
5. Aghion and Tirole (1997) argue that the more subordinate a principal has the more real authority the agents will have or, in other words, the more likely it is that decision making will be delegated. Meagher and Wait (2009) have found that decision-making rights are more likely to be centralised to a higher level of management when there is an increase in the number of workplace units undertaking the same activity. Can the two findings be reconciled? What does this say for the theory of Aghion and Tirole?
6. Discuss the costs and benefits of specialised task assignment relative to broad task assignment. What variables are likely to be particularly important in determining the optimal choice between alternatives?
7. Evaluate the following statement: “It is best to organise as a matrix organisation. Matrix organisations combine the best of both worlds – functional excellence and product focus.”
8. See the Bagby Copy Company case study on pages 413-414 of the text and answer the three questions. 9. Question 13-6 on page 418 of the text.
10. Question 13-7 on page 418 of the text.
Delegation E = 0.4
ECOS3003 Tutorial 4 1
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