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Lecture Notes 2

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AYB321 – STRATEGIC MANAGEMENT ACCOUNTING Lecture 2: Organisational Architecture Economist’s View of Behaviour  Economic choice: o Limited resources, unlimited wants o Assigning priorities to wants – chose most preferred option  People are not necessarily selfish  Opportunity cost: cost of using a resource for a given purpose is its value in its best alternative use  Marginal costs and benefits are the incremental costs and benefits associated with making a decision  Managers responses to problems are likely to depend on their understanding of people’s motives and their forecast of people’s reactions – their responses thus depend on their underlying model of behaviour. Most managerial actions attempt to change the behaviour of individuals.  Management need to understand what motivates their employees before choosing a policy to address the situation. There are 5 models: o Economic model  Assumption: individuals act to maximise their utility  Implication: align interests of employee with the firm – provide bonuses to hard workers and make decisions which increase firm value  Managers can impact behaviour by appropriately designing the opportunities facing individuals  Most useful model in reality – most consistent explainer of behaviour, most useful to managers as it provides concrete guidance on how to alter behaviour. Desired behaviour can be encouraged by changing the feasible opportunities facing the decision maker.  THIS IS THE MODEL USED IN AYB321 o Happy-is-Productive model  Assumption: exert high effort when happy (not because of rewards)  Implication: increase job satisfaction e.g. higher pay, gym memberships o Good-citizen model  Assumption: employees place interests of the company first  Implication: communicate what is required by employees o Product-of-the-Environment model  Assumption: behaviour of individuals is determined by upbringing  Implication: focus on hiring and firing o Only-Money-Matters model  Assumption: people only respond to monetary incentives – misinterpretation of economic model  Implication: use monetary incentives only  NOT A VALID MODEL Incentive Conflicts with Firms  Individuals are creative maximisers of their own utility  Manager/owner conflicts: o Choice of effort – free rider problem e.g. larger team = people working less hard o Perquisite taking – giving bonuses o Differential risk exposure o Differential horizons – NPV of market value Agency Theory  Agency relationship: one party, the principal, engages another party, the agent, to perform some service on the principal’s behalf  Many agency relationships exist within firms o Both parties gain some benefit e.g. employer/employee. It is in the best interest of both parties to make it work. It is the role of both to try to minimise conflict which results in costs  Incentives of principals and agents are not naturally aligned which leads to agency problems  There are three types off agency costs (used to reduce conflict): o Monitoring costs: incurred by the principal e.g. employee auditors o Bonding costs: incurred by the agent e.g. purchase insurance o Residual loss: loss in gains from trade that results due to the divergence of interest in the agency relationships Total Agency Costs = Monitoring Costs + Bonding Costs + Residual Loss o There is a maximum which can be spent on monitoring and bonding costs. o Maximise spending in these areas until they are fully offset by the residual loss Implicit Contracts  Promises and understandings e.g. suppliers will not shirk on quality  These are difficult to enforce in a court of law as not explicit Reputational Concerns  These are a powerful force to motivate contract compliance  The market can impost substantial costs on individuals for un
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