程序代写 ECOS3003 Lecture 3

Reference: Chen (2000) Promises, Trusts and Contracts, JLEO v16, n1, 209-232 Basic Idea – people are ‘trustworthy’ and will be honest unless something significant
Induces them to be dishonest Buyer-Seller relationship
waiter provides service quality q
buyer/diner pays tip

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ECOS3003 Lecture 3

Solve by backwards induction
What do we observe in reality? Why? – reputation?
– what about trust? Disutility from breaking implicit contract (social norm) Utility for buyer
B – P if pay for the good U=
B – k if cheat – don’t pay k is the disutility from breaking implicit contract
P is the implicit price for a quality good
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Break implicit contract if k

P
If k  {k1,k2} k1 < P < k2 What will the seller do – provide quality or not? - if most buyers have k1, do not provide quality - if most buyers have k2, provide quality good ECOS3003 Lecture 3 3 More explicit: Buyer γ prob k = k1 (1 – γ) prob k = k2 P implicit price, C cost of supplying quality good The choice for the seller is π(q=H) = γ(-c) + (1 – γ)(P – c) = (1 –γ)P - c π (q = L) = 0 ECOS3003 Lecture 3 4 Provide quality when: (1–γ)P–c ≥0 P – γP ≥ c - γP ≥ c – P - γ ≥ (c – P)/P γ ≤ (P - c)/P Provision of quality when: - more trustworthy people - ‘mark-up’ higher (more profit on each sale to honest person) ECOS3003 Lecture 3 5 What about contracting? - cost of writing a contract on quality Contract between buyer and seller - if seller does not provide quality qH, penalty will apply of price will be 0 - cost of contracting could be M When will contract be used? - when temptation to cheat is large; that is P – k is large ECOS3003 Lecture 3 6 Say k1 = k2 = k < P - everyone will cheat (supplier will not provide the quality good at all without any protection) - assume the cost of contract needs to be paid for by the buyer Buyer willing to write contract on quality when: U=B–P–M>0 orthat B–P>M
– more likely to write a contract when M is small; easy to contract on quality – when B – P is large; that is, the benefit of getting quality is very high
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Can think of problem other way around Seller wants to contract to ensure payment
– assume both quality options better than no supply
– again if k1 < P< k2 Then: P – c – M > γ(-c) + (1 – γ)[P – c] or that γP > M
Expected loss without contract loss from writing a contract
Again, write a contract when easy to do so and the potential loss from not having a contract is large
ECOS3003 Lecture 3 8

Decision rights: level of empowerment
– focus on a single decision right
– where should it be located in the firm?
Assigning tasks and decision rights
– an organisation has to package the totality of tasks into smaller blocks and assign them to particular individuals and or groups
– through process of designing the organization specific jobs are created (teaching, research, administration – lecturer’s job)
Jobs have two dimensions – variety of tasks
– decision authority (focus here)
Issue of centralisation versus decentralisation (level of firm’s hierarchy to place
the decision right
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Centralisation versus decentralisation
Benefits of decentralisation
1. Effective use of local knowledge
– local managers managers more likely to know about local demand/price sensitivities/tastes
If decision centralised
– have to transfer the knowledge
– or have decision made by uninformed
Decentralisation of decision rights links decision-making authority with specific knowledge and can reduce the costs of information transfer & processing
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2. Speed of decision making
3. Conservation of management time
– opp cost of senior managers’ time
4. Training and motivation for local management
– decentralising helps attracts talented employees and provides training for them
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Costs of decentralisation
1. Incentive problems
– local managers do not necessarily have strong incentives to act to max firm value (own objectives)
– could be need for incentive scheme, but can be costly/impossible
2. Coordination costs and failures
– local managers may ignore interaction with other divisions/plants etc
3. Less effective use of central information
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ECOS3003 Lecture 3 13

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Management implications
Costs and benefits of decentralisation changes overtime
– how will optimal decentralisation vary over time and across firms
Across firms:
– environment a major determinant of org architecture (technology, market conditions, regulation)
Net benefit of decentralisation highest in rapidly changing (unstable) environments
– when market conditions change frequently & technologies change might need to use local knowledge
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– More stable environments – centralise decision making – More decentralisation with more markets entered
– broad number of products (need more specific knowledge)
– differentiated products that need price premiums (strategy needs knowledge of customer demands etc
– lower costs of production could lead to centralisation
– coordination between plants (centralisation)
– firm size increases the no. of decisions that need to be made
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Recent trends
Increase global competition
– need to have higher-quality products meet demands of customers more quickly
– information to improve quality, customer service and efficiency of lower levels
– competitive pressure could increase the benefits of decentralisation Technology changes
– rate of technological change, needing quick response
– innovation can prompt firms to decentralise decision rights when important aspects of new technology at lower levels
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Technology can change the costs of information transfer
– can assist decentralisation (easier monitoring)
– can also promote centralisation (local information can be transferred
less costly to central organisation
Technology changes – reduce need for middle managers (middle managers transfer info to and from employees, monitor, coordinate
– easier to do now with new technology – change role for middle managers
ECOS3003 Lecture 3 18

Assigning decision rights to teams
Team – many different types of work groups that have decision-making authority (teams, committees, task forces, …)
Firms grant decision rights to teams for:
(1) manage activities (2) to make products (3) recommend actions
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Why assign decisions to a group as opposed to an individual?
1. Improved use of dispersed specific knowledge
– encourage transfer of knowledge (decision by consensus or vote) 2. Employee buy-in
1. Collective action problems
– manipulation
2. Free-rider problems
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Implications
When is a team good?
– when relevant specific information for decision dispersed among individuals & where costs of collective decision making and controlling free-rider
problems and lower Optimal team size?
– increasing size increases knowledge base
– increasing size increases free-rider problems
– increasing size increases collective decision-making problems
ECOS3003 Lecture 3 21

Decision management and control
Decision making process has 4 steps – initiation
– ratification
– implementation – monitoring
Definition:
Decision management – the initiation and implementation of decisions Decision control – ratification and monitoring of decisions
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Basic principle: allocating decision rights
– If decision makers do not bear the managers do not bear the major wealth effects of their decisions, decision management and decision control
will be held by separate decision makers.
When employees don’t bear the full wealth effects – incentive problems
– granting both DM and DC to an employee will encourage perverse behaviour
Only when decision maker is residual claimant should DM & DC be together. In a hierarchy, an individual have both DM and DC, but for different decisions
– eg div manager has approval rights over certain initiations of lower-level employees
– request authorisation for division expenditure
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Influence costs
Attempts to limit discretion
Benefits – reduces resources expended on individuals trying to influence decision and decision makers
Costs – not use information that could be helped make a better decision (but this is costly to provide) trade-off
When decision have little effect on overall profits, but greatly influence welfare, bureaucratic rules more likely
ECOS3003 Lecture 3 24

Formal and real authority in organisations
Aghion and Tirole 1997, JPE, v105, n1, 1-29 Formal authority – the legal right to decide
Real authority – the effective control over decisions
Can be a separation between who ahs the legal right to make a decision with the actual way decisions are made
Why might someone without formal authority have real authority?
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Principal – has formal authority
Agent – hired to collect information about a project P can implement one or zero projects
Projects n ≥ 3 potential projects
– all look the same ex ante
– project k associated with benefit Bk for P; bk for A – no project B0 = b0 = 0
– some project sufficiently negative payoffs, so won’t choose a project at random
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2 projects
– B > 0 to P and other zero – b > 0 toAand other zero
Ex ante prob that same project is preferred is:
β – parameter of congruence (ie P’s preferred project is good for agent) α – prob that A’s preferred project is good for P
Preferences:
P: Bk –w (canassumew=0) A: U(w) + bk (w = 0)
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Information
– each party can invest resources in discovering info about projects
– at cost gA(e) A perfectly learns payoffs of projects with prob e; with prob (1 – e) uninformed
– at cost gP(E) P perfectly learns payoffs of projects with prob E; with prob (1 – E) uninformed
Investment occurs simultaneously
Assumptions:
– gA(.), gP(.) increasing and strictly convex
gi’(0) = 0
gi’(1) = ∞ for i = A, P
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– P formal authority, p right to decide (can overrule subordinate) If uninformed can rubber stamp A’s recommendation since α > 0
Proposes formal authority structure
A and P invest in finding info
Communication
Controlling party makes decision
– A-formal authority: independent agent A has right to decide (cannot be overruled
ECOS3003 Lecture 3

Under P-formal authority
UP =EB+(1–E)eαB–gP(E)
UA = Eβb + (1 – E)eb – gA(e)
Under A-formal authority
UPd =eαB+(1–e)EB–gP(E)
UAd =eb+(1–e)Eβb–gA(e)
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Under P-formal authority
let the solution be E
BeBg’ (E)0 P
(1e)Bg’ (E) P
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UA (1E)bg’ (e)0 e A
(1E)bg’ (e) A
Let the solution be e
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With P-formal authority
– E higher the stake her stake (B)
– E lower the higher α (congruence parameter) and the agent’s effort
– e demonstrates more initiative the higher the private benefit and the lower the P’s interference (E)
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What about under delegation?
Let the solution be Ed For the agent:
UPd 0(1e)Bg’ (E)0 E P
Let the solution for the agent be
UAd 0(1E)bg’ (e)0 e A
ECOS3003 Lecture 3

As P cannot overrule A puts in more effort into discovering projects
P can get overruled, hence puts in less effort so that
ECOS3003 Lecture 3 35

Willingness to pay for authority: Bk(1 – αk) / bk(1 – βk)
(a) Only decisions that are relatively unimportant to P should be delegated
(b) Decisions for which P cannot trust the agent (αk low) or for which the agent
can trust the P (βk high) should not be delegated
ECOS3003 Lecture 3 36

What about when formal authority cannot be assigned?
P has incentive to intervene and cannot commit not to do so
If A-formal structure optimal, prefer to get A to invest more in decision making. But need a credible way for the P to not but-in on decisions
(i) increase P’s span of control; overload
Note – a fast growing form implies more real authority for subordinates – hence more investment by A. A slow-growing form implies less real authority and subordinates have incentives to invest stifled.
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– Multiple principals
– split returns, reducing B to B/2, …, B/n hence lower’s P’s incentive to invest
– split decision making – Urgency
– reputation for not intervening (a patient supervisor will weigh up future loss of effort from A from intervening from benefit from one project
– maybe commit to only overrule in dramatic/ extreme cases
ECOS3003 Lecture 3 38

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