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Ideas of the Business Organization Course


1. Economists view of behaviour
Individuals decide rationally comparing marginal costs and marginal
Sunk costs are sunk, but opportunity costs matter a lot.
Other models of behaviour (alternative to the economist view):
happy is productive, only money matters

2. Markets and organizations
Prices coordinate individual actions and resource allocation. Prices
also convey general, useful information.
Transaction costs = Contracting costs = costs involved in market
transactions (searching, comparing, testing, etc) other than the
Firms exist because of the contracting costs of using the market.



3. Economics of strategy
Strategy is the long-term vision of the firm on how to create and
capture value.
Value is created, mainly, by (a) introducing new products or services
or (b) reducing the transaction costs (consumer-borne or producer-
The potential for capturing/keeping value relies on creating market
power (some form of monopoly)
Many large firms are diversified: it not a good idea if done to reduce
earnings volatility.

4. Incentive conflicts and contracts
The Firm is the centre of a network of contracts (legal relationships).
Large firms are more bureaucratic and difficult to manage and
control; this makes delegation (agency relationships) necessary.
Agency relationships can create problems: (a) pre-contractual:
adverse selection (b) post-contractual: incentive conflicts.
The Principal will need to establish the appropriate incentives for
the agent but in general it is not optimal to resolve incentive
conflicts completely if monitoring costs are too high
Reputational concerns and implicit contracts are very important.



5. Organizational architecture and decision rights
The allocation of decision rights: Who decides what?
The environment (technology, markets, regulation) determines the
strategy and the architecture of the firm
In practice, the main debate is centralization v. decentralization:
o central.: better coordination but overloads the center
o decentr.: better use of local info but creates agency problems
Decision management and control needs to be separated
6. Vertical integration
Production of goods and services is organized through a vertical
chain: from raw materials at the top to consumers at the bottom
Market discipline is the main reason for on spot transactions
The main reasons in favor vertical integration:
o To avoid contracting costs, including incomplete contracting
o To avoid the hold-up problem, for specific assets
The outsourcing decision corresponds to a point in a continuum
Contracting with distributors: free-rider and double mark-up,
7. Incentive compensation and performance evaluation
Incentive conflicts exist within firms because (2&3):
o principal and agents have different goals; AND
o the principal cannot observe agents actions
The optimal compensation should strike a balance between:
o risk sharing: reduce the risk borne by the agent
o incentive provision: induce the agent to exert effort
In general, apply the Informativeness principle
Individual performance evaluation: ratchet effect, relative, subjective
Divisional performance: cost, expense, revenue, profit, investment.


8. Corporate Governance
Corporations have the legal standing of an individual; some
corporations are privately-held and other are publicly-traded.
Raising capital from investors is the primary reasons why firms go
The performance based-compensation in top management is very
important (80%).
9. Ethics
Business Ethics is an elusive concept
If the corporation is to survive, it needs to maximize value to its owners
The companys reputation improves its brand-name capital with
positive impact on results
Its not about changing employees preferences, its about setting the
right incentives
Even if ethics programs fail, good communication and
education/information adds value to the firm.