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AYB321 Lecture Notes - Indirect Costs, Free Rider Problem, Agency Cost

3 pages24 viewsFall 2012

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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
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.
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
Implication: use monetary incentives only
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):
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