RHEA JOY C.

JOVEN MBA SAT 3PM- 6PM

CHAPTER 6 BRIEFER

THE ORGANIZATION OF THE FIRM

This chapter discussed about the optimal institutional choice for input
procurement and the principal–agent problem as it relates to managerial
compensation and worker incentives. The manager must decide which inputs will
be purchased from other firms and which inputs the firm will manufacture itself.
Spot exchange generally is the most desirable alternative when there are many
buyers and sellers and low transaction costs. It becomes less attractive when
substantial specialized investments generate opportunism, resulting in transaction
costs associated with using a market. Spot exchange occurs when the buyer and
seller of an input meet, exchange, and then go their separate ways. When
market transaction costs are high, the manager may wish to purchase inputs from
a specific supplier using a contract or, alternatively, forgo the market entirely and
have the firm set up a subsidiary to produce the required input internally. In a fairly
simple contracting environment, a contract may be the most effective solution. But
as the contracting environment becomes more complex and uncertain, internal
production through vertical integration becomes an attractive managerial strategy.
A contract is a legal document that creates an extended relationship between a
particular buyer and seller of an input. The chapter also demonstrated a solution to
the principal–agent problem: Rewards must be constructed so as to induce the
activities desired of workers. For example, if all a manager wants from a worker is
for the worker to show up at the workplace, an hourly wage rate and a time clock
form an excellent incentive scheme. If it is desirable to produce a high level of
output with very little emphasis on quality, piece-rate pay schemes work well.
However, if both quantity and quality of output are concerns, profit sharing is an
excellent motivator.