Global Challenges

Future Business
Jos Tavares

2015

Lecture 11
Inside Firms
INSIDE FIRMS
 Stakeholders in the Firm
Owners and investors
Employees
Customers
Suppliers
Distributors
Creditors and banks
Government
Public at large

3
 Why do we have firms?

Firms are a hassle

Many legal formalities

Dividing responsibilities - offices and directorships
Issuing stock and determining stock rights
Potentially losing control of ones own business
 Whats the alternative?

Basic premise

Business activity requires coordinating the interests of

individuals and firms with differing skills and interests.

This coordination can be done by contract

Why not do everything through contracts?

 Firms versus Markets

The firms benefits The firms costs

specialization in teams shirking

transaction-cost savings agent misdirection
corporate capital formation rent seeking
morale and culture
 Theories of the Firm

Neoclassical theory
perfect competition and profit maximization

Assumptions:
Single-minded purpose
Rationality
Operational rules: MC = MR
 Transaction Costs

Transaction costs the costs of providing for

some good or service through the market
rather than having it provided from within the
firm
Ronald Coase

Search and information costs

Bargaining and decision costs
Monitoring and enforcement costs
 Choice Between Market and Firm
Economic activity can be conducted across markets
or within a firm.
The choice between market and firm depends on
which transaction costs are lower:
Markets (contracts) are attractive when the costs of
opportunism are lower than agency costs
Intense competition in the market
(e.g., many competitors; no transaction-specific costs).
High monitoring and bonding expenditures
Firms (agency) are attractive when agency costs are lower
than those of opportunism.
 Coases Theory of the Firm

Developed by Ronald Coase in 1937

Took decades to become accepted.

Ronald Coase
 Transaction costs

Three dimensions along which transaction costs vary:

asset specificity
uncertainty
frequency of transactions

GRAPH
 Behavioral Theories of the Firm
Herbert Simon

Firms multi-goal, multi-decision, organizational coalitions

Managers cannot meet aspiration levels of all stakeholders
Imperfect knowledge and bounded rationality
Managers cannot maximize, instead they have to satisfice
 The Problem of X-inefficiency

X-inefficiency - the difference between efficient

behaviour of firms assumed or implied by
economic theory and their observed
behaviour in practice.

- cost higher than it needs to be, or benefit

lower, because the firm has margin to
operate inefficiently
 The Principal Agent Problem

The principal-agent problem

the difficulties that arise under conditions of incomplete and
asymmetric information when a principal hires an agent

The agents actions affect the principal's payoff

but they are not directly observable by the principal, or they are not
verifiable by outsiders.

The central dilemma - how to get the employee or contractor

(agent) to act in the best interests of the principal (the
employer)
the employee or contractor has an informational advantage over the
principal and has different interests from the principal.
 Case Study
Moby Dick, or The Whale
or
The Conduct of Men in Collective Endeavors

Examine the discussion of individual and collective objectives,

incentives and agency in Chapter 46 of Herman Melvilles Moby Dick
 Moby Dick, or The Whale
or
The Conduct of Men in Collective Endeavors
Summary
Ishmael here writes that, although Ahab is singularly devoted to the catching and
killing of Moby Dick, still he is not unmindful of the normal purpose of a whaling
ship, which is to kill as many sperm whales as possible, for the collection of sperm oil
and the enrichment of the crew. Ahab, Ishmael states, understands that even though
members of the crew are for his quest at the moment, they might just as easily
turn away from Ahabs command if left to their own devices for too long, and try to
take over the vessel in a mutiny, since Ahab is so demonstrably maniacal.

Thus, Ishmael writes, Ahab knows he must keep his crew occupied, just as knights on
a quest for the holy grail were occupied with intermediate adventures along the
way. And Ahab also knows that any whale the Pequod can spot and kill is an
opportunity to employ the crew in the catching of the White Whale, which still forms
the central purpose of Ahabs tortured life.

Analysis & Themes

Ahabs rational deduction herethat he must entertain the crew as the Pequod
makes its way to find Moby Dickdemonstrates that Ahab is not completely seized
by his madness. He is, in other words, aware that others on the vessel might not
share his unbending desire to kill the White Whale. Thus, Ahabs insanity takes on
a peculiar rationality and logiche is so devoted to killing Moby Dick, he can will
himself into a kind of sanity in order to protect himself and continue the chase.

On Chapter by Chapter themes

http://www.litcharts.com/lit/moby-dick/themes#fate-and-free-will
 CEOs and meritocracy?

Highlight the facts and problems related to CEO incentives,

performance and accountability highlighted in the video

http://www.youtube.com/watch?v=CHPedxzxziw
 Video Case Study
As Work Gets More Complex, 6 Rules to Simplify

As Work Gets More Complex, 6 Rules to Simplify

Yves Morieux
11:58
https://www.ted.com/talks/yves_morieux_as_work_gets_more_complex_6_rules_to_simplify#t-322374