Apuntazos Eoam PDF

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Notes taken from the readings and powerpoint presentation at

class
Economic Organizations and Markets (Universitat Pompeu Fabra)
Studocu no está patrocinado ni avalado por ningún colegio o universidad.

Descargado por Marta BM (martaboschmore@gmail.com)
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Economic Organizations, Institutions and

Markets
2n term
Benito Arruñada
CASE BASED INTRODUCTION
0. Linking Business Economics and Organizations and Markets through

cases
READINGS
Case 1. Taxi Regulation
Reading 1
Competition between taxis and private services such as Uber and Lyft.
- Has caused some detrimental effects: clogging streets and less demand in public
transport, which is forced to raise fares and cut services to compensate for the
shortfall, thereby driving more people to Uber and Lyft; longer waiting times for
rides; increase in prices.
- Some benefits: less traffic on the road, shorter journey and a more fiscally
sustainable public-transport system.
Reading 2
Are Ubers a substitute or complement for taxis?
- Uber is easier than taking a taxi: more commodities (especially at night) + faster
(no need to pay at the end due to smartphones) + easier to call on one (app in
smartphones).
- Not everyone that takes an Uber would’ve taken the subway or bus or biked.
- Uber’s benefits are from substituting taxis rather than complementing them.
- Uber’s not done yet; could take more market than it already has.
TAXIS: What do we see?

- Conflict between taxis & VTC (Uber/Cabify):
 Taxi drivers complain on surplus capacity, driving empty, low prices, violence,
etc. But mainly entry and competition by VTCs.

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 VTCs complain on barriers of entry.

 Solution: shared monopoly with licenses given for free.
- Users complain on:
 Low quality of service: dirty cars, not knowing the route, etc.
 Prices: high, cheating, variable.
Quality is an important variable to take into consideration, because sometimes it may

not be perceived by us. For example, if the driver is reckless behind the wheel, he/she
may be endangering our lives. This is a clear example of a moral conflict.
In addition, “bad drivers” will end up taking over the “good” ones because they might
try to convince you to pay more or spend less money on expenses (such as proper
cleaning products, for instance), and therefore earning more profits than the latter.
Taxi production structure
There are no “market failures” without business opportunities. Every time you end up
with a market failure, you make more money.
- Pure market: Possible failures?

 Information asymmetry
- Firms as solution: with free entry?
 It may not be possible for just one driver to complete the job → Firm +
association of drivers
 Firms can assure a certain level of quality. However, with free entry, that quality
could decrease because there would be no regulations needed.
A clear example of an specific asset are London drivers. In order to get their license and
become taxi drivers they need to pass an exam. Therefore, without this specific job,
these workers cannot look for a job in a different sector.
- Regulatory solutions
 Entry: licensing → monopoly
 Supervision: effective?
◦ For example: periodic car check-up exam

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- How does it work?

 Monopoly rents —or quasi-rents?
 Is supervision effective?
- Technological changes —which ones were relevant?
 Matching
 Quality assurance
Known tools
- Markets vs firms vs regulations
- Search, coordination costs
- Information asymmetry, agency
 Moral hazard (example of the reckless driver)
 Adverse selection
- Free riding
- Quality assurance
- Specific assets (example of London’s taxi drivers)
 Incentives
 Rents vs quasi-rents
- Economies of scale
 Conventional & new? Network economies
Additional tools
- Comparative advantages of markets vs regulation vs firms: the economy as hybrid
 How do they change with technology?
- Regulation analysis from two perspectives
 Normative: externalities, property rights
◦ Is car pollution really an issue for this taxicab case?
 Positive: rent seeking, info asymmetry in politics
- Organizational forms: coops, franchising
- Behavior: learning, risk & change aversion, etc.
Case 2. Public bureaucracy

- Even the best government cannot know what millions of sovereign individuals need
better than they do themselves ~ Hayek and Friedman. → Government Spending is
tricky.

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- In the past, government spending used to be far less than what it is today.
Governments have lost some power and nowadays need to rely on private firms.
However, in other areas they’ve gained more power such as wages, public health,
gender-pay gaps, etc.
- Politicians have their own incentives to expand their state, and instead of closing down
old programs, decide to introduce a new one.
- Costs are spread across all taxpayers while benefits tend to be concentrated.
- Technology has served to strengthen the bureaucracy’s grasp.
- Governments spend more money in “superior goods” which are those people purchase
more due to an increase in their income. Examples are education or health care.
- Solutions are needed in order to allow governments to spend more and make paying
taxes or contributing more appealing to citizens.
Public bureaucracies: what do we see? What have you read?

- UPF is a public bureaucracy. Perhaps the most important institutions in our economy
are public bureaucracies. They are essential.
- Public expenses have increased these past years, especially with covid.
- Our economies are so connected that economic decisions from the government are
interconnected. However, they have differences in the way they apply certain rules or in
their culture. That’s why we cannot strictly compare them.
- Does that mean we cannot compare countries? No, because we could do it by grouping
them in similarities. For example, Sweden with Denmark, or Spain with Portugal.
- People want more public services. And in the army? Or healthcare? They might think
they don’t need it right now, as there is no war, but no one can assure us that this will
still be the case in a few months or years. This is what we call information asymmetry,
because we cannot tell what can happen in the future.
- Do we know the amount of expenditure the government has to spend? Yes, but it’s
hard. Each country has a different belief about the money they need to destine to the
army or healthcare, thus the existent differences between countries.
- Do we need public bureaucracies?

- Public perceptions
 Wages → Is there a way to compare salaries? Every sector is different, and each
job has its own characteristics, that’s why in order to set the wages, we need the
economic tool of “supply and demand”.

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- How do they compare with private firms?

 Ownership → Owners are those who receive the profits. In the public sector those
are the users and taxpayers. In some aspects, they both contribute the same way
whereas sometimes they don’t and don’t receive the same services. For instance,
elders don’t go to university and therefore can’t benefit from this service.
 Organization → How are public services organized? Managers, organizational
forms, by divisionalization (the way certain divisions behave in a firm), etc.
UPF for example can be a division of a bigger bureaucratic institution such as the
Generalitat. But we could also see UPF as the big bureaucratic institution with
some divisions at their disposal.
The traditional way of organizing public institutions are through bureaucracies. In
bureaucracies everything is regulated with rules. Conversely, in the private
sector, for example, there is free choice regarding the methods or the
decentralization they want to carry out.
 Efficiency → You either go through the challenge of providing efficient public
services (public universities, for example), or you get rid of them by transforming
them into a private institution.
What is the production structure of public bureaucracies?

- The classic economic questions
 For whom → everybody
 How? → A mix of techniques that vary from different countries to public or
private sectors.
It’s the State that must decide how they’ll operate: will they pay for their
students’ university tuition? Will they convert public universities to private? How
will we keep being public with new subventions from the private sector? Etc.
We also need to consider sometimes the government may not be the ideal
institution to control a specific public sector. For example, will politicians be
great at making important hospital decisions related to their patients’ health?
Probably not.
- Going deeper
 How are they incentivized? Units? People?
 Which “people”? Civil servants? Who else?
People want efficient and high quality services WITHOUT paying the price for it.

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In private sectors, there is a trade-off (price-quality; depending on the quality,

you pay one price or another). However, in public bureaucracies, no matter the
amount of services or the quality of these whatsoever, the price is the same.
Spain is the country in Europe with the lowest fees for their services. That
explains why we face bigger problems. The funny thing is that people loathe
paying taxes, failing to realize the lower the fee, the poorer the service’s quality
will be.
- How about private bureaucracies? Are they different? How?
Within private firms you have the same bureaucracies, and therefore the same
problems. A lot of divisions will operate and act as public bureaucracies, with a budget
to spend and a main service to provide.
Known tools
- Market vs. politics
 market failures
 political failures
There are different incentives. We prefer becoming a better manager (market)
than a better citizen (political).
- Organizational forms: e.g., ownership in corps
- Monopoly: causes and consequences → Applied to public bureaucracies: if governments
lower their prices to 0, they will overproduce (more demand) and as a consequence, for
example, waiting lists would be extended.
And how do we overproduce when we just said we have waiting lists? Because processes
are too low and demand is too high. As we cannot give a service to everyone,
governments will allocate resources within different organizations (in order to try to
satisfy the maximum demand as possible), depending on preferences, risks, etc.
Therefore, there will be competition between different public firms, ministries, etc.
And as all of them want to get as much money as possible, “budget battles” will take
place.
In addition, considering users won’t pay (prices = 0), what can we do? Use our users
strategically to fight for our prices.

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- Divisional objectives vs firms objectives
Additional tools
- Comparative advantages of markets vs. politics
 Identifying systematic failures → complementarities
 Failures of both types
◦ Behavioral
◦ Externalities
- How to recognize public bureaucracies
 Expand the organizational forms we studied last year:
◦ Divisional centers: cost, revenue, … expense centers
◦ The dynamics of budgets
◦ Internal markets
 Role of incentives → Role of management
Case 3. Corporate Social Responsibility (CSR), or Environmental, Social & Governance

(ESG)
- A solid governance structure contributes to deliver products at the lower cost, and
there shouldn’t be constraints on their choices for can create inefficiencies that are paid
by consumers.
- E&S can be used to produce incentives to provide products that accommodate
consumers’ utility functions. Asset markets can help accommodate any E&S issue. If E&S
actions are valued by investors, they reward it with higher share prices which imply
lower expected stock returns and costs of capital.
- E&S, on the other hand, can also raise production costs which leans against the benefit
of lower costs of capital and so investors get lower expected returns.
- Thus, firms take the prices for expected payoffs and payoff risks as given and the
optimal rule for production decisions is max shareholder wealth, given these prices.
- The ESG movement argues that the resulting decision rule should be max shareholder
welfare, not max shareholder wealth because not everyone across the shareholders or
managers will have the same interests. The max shareholder wealth rule is a one-
dimension alternative with lower contract costs than max shareholder welfare. A
portfolio perspective points to max shareholder wealth as the appropriate decision rule
for firms even when consumers and investors have strong tastes for ESG virtue.

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- Every activity creates negative externalities. Activism that induces consumers and
investors to value E&S-friendly products may be a better (though also imperfect)
alternative to control it than regulations imposed by the government. On the plus side,
activism that affects the behavior of consumers and investors is a market-oriented
approach that may adjust more flexibly to unpredicted outcomes than political
solutions.
Corporate Social Responsibility (CSR). How do people feel about firms?

- Cases of complaints against firms?
- Which firms? E.g., small vs big? Local vs international?
 From whom do you prefer to buy?
 Where do you want to work?
- How are firms portrayed in movies?
What do we mean by making firms “responsible”?

We have a clear idea about what “responsible” means. However, it is not the same
criteria we use to define this word when talking about individuals and firms. For
example, in economics, responsibility can be used to describe the different kind of
contracts between individuals, whether they pay them or not, or the different
production functions (we assume it’s optimal), etc.
- Legally liable: e.g.:

 Return bad merchandise, pay for accidents, etc.
 Abide by the law: essential for market action to be socially optimal.
- Morally responsible?
 Which moral code?
◦ Socially accepted? Church? Taliban?
 Who “in the firm”
◦ Whose moral code? Managers? Clients? Shareholders?
 How? Meaning what?
◦ For example, allocating resources in a certain manner? But, how?
At the end of the day, responsibility means who pays the bills.

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- Maximizing shareholders’ wealth vs welfare.

Firms have a peculiarity: what do these contracts have in common? All employers are
paid a stable amount of money depending on their individual performance. However,
only top managers and shareholders are paid an extra bonus that varies depending on
the residual value of the firm at that time.
Known tools
- Firms as a “nexus of contracts” → In reality, firms are like a market and its contracts
would be the individuals in it.
- Corporations
 Separation of ownership and control: For instance, the difference in contracts
between shareholders and managers.
- Dual tasks and multiple objectives in an agency context
- Information asymmetry and externalities → market failure
- Information asymmetry and poor incentives → political failure
- Safeguarding contracts
 Concepts
◦ Signaling: safeguarding through bonding investments
◦ Reputation: safeguarding role of a relational capital
 Areas
◦ Quality assurance
◦ Attracting and retaining employers
Additional tools
- How the Rule of Law works
- Comparative advantages of markets vs politics
 Reputation in the market vs the rule of law: private vs public “ordering”
 Behavioral foundations: the proper role of morality
◦ Law vs morality
◦ Moral circle vs positive analysis of costs and benefits
Morality changes a lot. How do we decide as a society what is morally correct
and what is not? Years ago it was the church with certain conducts labeled as
correct or wrong. Back then it was easy to know the moral code. Nowadays we
don’t, because there are a lot of factors and new attitudes constantly

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changing the perception of what the correct conduct is, thus the moral code.
For example, something that influences the moral code is social media.
- Managing fashionable concepts: E.g: CSR → ESG

 ESG = environmental social and governance
 Fashion in buzzwords or substantive conceptual change?
- Two practical tools —being more familiar with:
 Social perceptions about firms
 Unintended consequences of human action
BLOCK 1: INDIVIDUAL BEHAVIOR

1. New cognitive perspectives
Reading 1: The Need for Rationality in a Hostile World
- Rationality is the ability to use knowledge to attain goals, and there are two types:
 Instrumental rationality → focuses on optimizing goal fulfillment; basically to get
what you want (expected utility).
 Epistemic rationality → the way our beliefs map onto the real world.
And both concepts are related. To fulfill our goals, we need to base our actions on
beliefs that reflect reality.
- Our emotions (if they’re regulated correctly) facilitate our rational thought and action.
- Even if intelligent people tend to be more rational, these [rational] thoughts can be
teachable.
- System 1 (fast thinking) and System 2 (precise analytic cognition)
- Meliorists assume human reasoning is not as good as it could be, due to a lack of effort.
They believe that when being presented between present and long-term personal well-
being, we should override present wants that originate from the ultimate goals of the
genes (for example, not eating a doughnut to get a “slim healthy body”).
- Panglossians have more faith in human reasoning and believe some experiments don’t
represent the real-world decision-making.
- Apologists recognize that human reason is suboptimal but they do not always attribute
these limitations as instances of irrationality (except when that person could’ve done
better). They believe there’s a way to enhance performance by presenting information
in a better suited way for our cognitive machinery. They defend that conflicting goals
often need to be adjudicated by System 2.

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- A benign environment is one where individuals rely on System 1, whereas in a hostile

environment (people need to “ignore what they know” because they are irrelevant)
System 2 overrides System 1 processes.
- The modern worlds creates situations where the default values of evolutionary adapted
cognitive systems are not optimal, and therefore puts a premium on the use of System 2
(deal abstractly with information) to override System 1 (in a context-specific way)
responses.
- System 1 individuals respond for profit.
- System 1 is full of automatic propensities to regulate our responses to stimuli in
environments that are not rapidly changing.
- Cultural diffusion allows knowledge to be shared, and benefits us from the knowledge
and rational strategies invented by others. Cultural freeloaders are those who add
nothing to the collective knowledge or rationality of humanity.
- Errors:
 Some rational thinking errors result from inappropriate System 1 biases that must
be overridden by the cognitively taxing operations of System 2, which most
people don’t have the capacity to do. This is the class of error that is highly
related to intelligence.
 Another kind of error less related to intelligence and more related to thinking
dispositions like actively open-minded thinking arises when people have the
decoupling ability but don’t employ it because of their impulsiveness and accept
the outputs of System 1 to readily.
 A third class of error arises when people have adequate intelligence and sufficient
reflective tendencies but have not acquired the specialized knowledge that is
necessary to compute the response that overrides the incorrect intuitive
response.
 A fourth class of error arises because not all mindware is helpful, and some is the
direct cause of irrational thinking → contaminated mindware. We can’t remediate
this kind of rational thinking through teaching.
- Myside bias (viewpoint) is best understood by looking at the nature of beliefs rather
than the generic psychological characteristics of people.
- We need be more skeptic of the memes (culturally transmitted idea) acquired,
especially those on our early lives. We need to learn to treat our beliefs less like
possessions and more like contingent hypotheses.

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- We need to rely on “institutions of rationality” to deal with the “Tragedy of the Belief
Commons”, where people benefit from rational tools without having to learn them
themselves, thanks to rules applied by cultural institutions, such as the internet.
- “Ideas are true or false, consistent or contradictory, conducive to human welfare or
not, regardless of who thinks them”.
Why individuals behavior?

People want to maximize their utility, and to do that we have to assume people respond
to incentives, except those who are obsessed with power.
Key dimensions in human conduct

- Economics
 Self-interest
 Rationality
- Observable deviations from:
 Altruistic cooperation: love, tips by tourists.
 Failures of rationality
- Variety across individuals, relationships, etc.
 Self-interested ←→ Altruist
 Rational ←→ Emotional
Business economics: Prospect theory (asymmetric value function)

- Defined on changes of wealth
- Aversion to losses → steeper for losses
- Decreasing marginal utility → concave in gains, convex in losses

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The dual systems in our brain:

- Emotional commitment → sometimes being committed to irrationality has its benefits,
especially in terms of honor, where certain countries when punish you if you insult
someone powerful.
Irrelevant options (“The Decoy Effect”) “señuelo”, “engaño”

- A certain portion prefers A to B
- Adding a “dominated” option C (“irrelevant) affects people’s decisions and they
believe that if more people go to C, then because it is near to B, they’ll take a similar
decision and so they’ll be safe because they will follow the rest.
- C is a decoy. Will C affect people’s opinion of A and B? If they were rational, NO. But
since we’re in real life, it does, causing people to move to the closer option to the
decoy.
- Therefore, for example, being B and having the decoy (C) near you, will bring you
more clients or attract more people to your business/product.
- A decoy in the model is irrational, but our minds interpret it as information relevant to
us (or that has been relevant to us in the past as a human species, due to the evolution.
Price
A
C
B
Distance
Role of rationality
- Source of human’s comparative advantage: cognition = we are cognitive specialists →
constrained flexibility and success.
- This specialization is what explains our successes and constraints.

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- Flexibility to adapt to our environment. We are more flexible than other species: for
example, we’re the only ones that have explored the moon.
- Our mind evolved to cope with this environment: “Environment of evolutionary
adaptation”.
How we succeed in being cognitive specialists

- Modular mind (≈ “apps” in smartphones)
 More efficient in using information with different structures in each environment
 Content-full of innate solutions (instincts, in brief)
◦ Grammar acquisition, sex attraction, fear, social exchange, etc.
- Adapted mind → risk of being maladapted:
 Cognition → technological change faster than biological evolution → success +
maladaptation
◦ Success because animals only adapt biologically
◦ Maladaptation because we change environment faster than instincts.
Reading 2: Human Nature and institutional analysis

- Specialization in cognition and technology constrains our design but also explains our
excellent environmental performance, which gives us a comparative advantage over
prey animals. However, as a downside we become maladapted to rapid changes in our
environment.
- Specialized modules allow our mind to develop mechanisms “better than rational”
because they minimize the use of information, speed up decisions and produce
sophisticated solutions.
- Intelligence allows us to develop new technologies, allowing as to outrun not only out
preys but ourselves too (we’ve changed our environment in the last ten thousand years
much faster than our own genetics could adapt to such change).
- The function of institutions is therefore to enhance our capacity to reason and
interact, allowing us to overcome our own evolutionary constraints, mainly through self
and social control.
- Our mind is powerful but economical in the use of resources. It spends resources in
solving problems which were relevant for survival in our evolutionary past, but it does
not care about those which were irrelevant.
- Our mind is also ecological in the sense that it is adapted to our common ancestral
environment of evolutionary adaptation and to our learning environment.

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- Emotions are necessary for rationality, and they’re also adaptive when they seem to
harm the individual and tend to be considered “irrational”.
- We feel more negative than positive emotions and we tend to grant greater weight to
losses than to gains.
- Clear examples of emotional maladaptation with economic consequences are:
 Risk aversion → emotional mechanisms that trigger automatic/secure responses,
creating asymmetry of gains and losses. Nowadays, however, instinctive risk
aversion may be leading modern humans to excessive prudence. We are risk
averse to avoid risks that we are programmed to (wrongly) perceive as affecting
our survival and reproduction.
 Weakness of will → we have trouble identifying what we want and being
consistent with it. This may be a natural consequence of two factors: conflict
between modules and maladapted discounting. Basically, our minds cause a
trade-off between specialization gains and transaction costs. This weakness may
emerge because of maladaptation to our current environment, which makes us
feel like it’s optimal to postpone gratification.
- Sometimes cooperation requires enforcement mechanisms to make sure that parties
comply, and these rely on innate instincts, such as genetic relatedness (cooperation
between relatives). Cooperative instincts and why are they maladapted:
 Genetic relatedness → by helping children, parents promote the survival of their
genes. This instinct is effective. Positive side: it does not require external
enforcement because parties are programmed to cooperate. Negative side:
motivates rent seeking in the form of cuckoldry (=adultery) and therefore
spending resources to avoid it. In addition, cooperation grounded on genetic
relatedness is limited to a few types of individuals, and does not allow much
specialization.
 Emotional commitment → Emotional responses often seem irrational and
maladaptive, as when we die to save a loved one or to punish an enemy.
However, these emotions are part of an efficient commitment strategy. For
example, if a criminal kills a spy, he will gain reputation and will make him seem
stronger. In a sense, ex post “irrational” emotions are introducing greater ex ante
rationality. Emotional commitment requires that prospective parties are able to
distinguish cooperative individuals from cheaters beforehand.
 The tools of reciprocity → Requires that participants be able to distinguish at
least compliant from cheating behavior after the transaction. Human beings seem

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to have developed specialized innate abilities to detect cheating behavior, as well

as to signal and distinguish cooperators, which make possible for human
populations to reach stable polymorphic equilibrium with different types. In sum,
reciprocity is grounded on complex mental tools of detection and commitment.
Two of these tools are our ability to detect cheaters and our urge to retaliate
when we feel that we have been cheated.
 Cheating detectors → Our ability to get the right solution is higher in a cheating
situation thanks to our use of mental resources that work faster and better than
when processing the abstract rules of logic.
 Strong reciprocity → We are willing to incur costs to punish cheaters even when
there is no prospect of further interaction. Interestingly, this propensity to punish
ends up achieving greater cooperation, when parties anticipate the possibility of
costly retaliation.
- Limits of cooperation grounded on cooperative instincts:
 The limits of instinctive cooperation → mainly within small groups of known
people. These limits are most prominent for genetic relatedness, which promotes
cooperation only among relatives, but other mechanisms have also their
particular, even if less strict, limits. Thus, most emotional commitment and
cheating detectors require personal interaction. Direct reciprocity is also limited
to relatively small groups because it requires to know others and to keep track of
their behavior.
 The unnaturalness of market exchange → The design and difficulties of
institutions that promote a certain type of exchange for which we are poorly
endowed by nature, are often connected to this intrinsic maladaptation.
- Institutions act as rationalizing and cooperative mechanisms that enhance our fitness
in new environments. They are, however, grounded on our human nature: in a sense
they “recruit” and mold our instincts to build more effective mechanisms. We can
understand instincts as:
 Instincts as building blocks of institutions → Institutions recruit instincts as
building blocks of their machinery, often to create enforcement mechanisms. For
example, food taboos (e.g., against eating pork) seem to be exploiting the
psychology of disgust during the period when children learn their food
preferences, probably to make for them more difficult to interact with members
of neighboring groups when they are grown up.

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 Institutions as complements of human nature → Filling the adaptation gap

between our ancestral and current environments requires managing our instincts
in both the rationality and cooperation fronts. In terms of rationality, the
paramount issue is one of self-control, postponing gratification, while in terms of
cooperation, it is fundamental to control antisocial behavior.
◦ Institutions as enforcement → allow human groups to achieve greater
cooperation within the group and makes them more competitive against other
groups. Here we have first party enforcement, where the party who acts as an
enforcer relies for punishment on emotions like guilt and shame; the second
party enforcement, grounded on reciprocity, as the receiving party is the one
who sanctions the defaults; and third party enforcement, where other people
act as enforcers, and it can be informal and decentralized (reputation and
gossip) or centralized (litigation).
- Nature and nurture, interact in a way that makes them not separable. They act as
complements more than as substitutes.
- Institutions mold the nurturing process and display a full array of enforcement
mechanisms that greatly affect our self and social control abilities. And institutions are
the product of intentional design, relying on instincts, as explained above, but
intentionally designed. This might reduce the influence of genetic selection, sitting
human beings at the wheel of their destiny.
- Institutions allow greater human interaction, enhancing specialization and multiplying
our productivity. Institutional enforcement not only boosts within-group cooperation by
punishing free riders but also enlarges the cooperative group.
- The process of institutional change is different from natural selection. It is constrained
by the genetic background, but is substantially influenced by learning, decision making
and imitation. And institutional change is also intentional, the consequence of individual
decisions (though not necessarily successful).
Instinctive rationality
- Obvious
 Hunger → search for food → feeding
 Disgust → Poisoning avoidance
 Fear → Mobilization of resources
 Sex drive → reproduction

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◦ In the interest of who? E.g.: the selfish gene?

- Harder to make sense of:
 Happiness → Effort? Why does it not last? → It serves as a motivation. The illusion
of happiness: it never lasts. Related to utility.
 Consciousness of oneself? → There’s an element of illusion: that we’re in control.
 Etc.
Instinctive rationality is better than rational

- Vision = 2D → 3D
- Is the horse coming or going?
- Presence of several heuristics (enabling someone to discover or learn something
for themselves) noticeable when only one is present.
 Poor perception
 “Anomalies” (often, no more than tricks)
Instinctive cooperation (1): Lack of facial control helps us trading

- Why is “acting” so difficult
- Why do we still have business meetings?
- Lie detectors
- Lovers: plenty of eye contact, pupils expand, etc.
Moral circle
- Identical mechanisms triggered
 Precluding certain actions (e.g.: killing) or treatments (considering the costs and
benefits of some actions)
 Reification of human beings → no guilt when treating them as things or insects
(killing enemies in war action)
- With circle borders culturally flexible
Reading 3: Homo administrans

- Standard social science model (SSSM) assumes that most behavioral differences
between individuals are explicable by culture and socialization, with biology playing at
best the softest of second fiddles.
- Dr Shane observes genetic influence over which jobs people choose (see chart), how
satisfied they are with those jobs, how frequently they change jobs, how important work

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is to them and how well they perform. Salary also depends on DNA. Around 40% of the
variation between people’s incomes is attributable to genetics.
- Genes do not, however, operate in isolation. Environment is important, too. Part of
the mistake made by supporters of the SSSM was to treat the two as independent
variables when, in reality, they interact in subtle ways.
- People exhibiting personality traits like sensation-seeking are more likely to become
entrepreneurs than their less outgoing and more level-headed peers. Dr Arvey and his
colleagues found the same effect for extroversion. There was, however, an interesting
twist in their study, which suggests that genes help explain extroversion only in women.
In men, this trait is instilled environmentally. Businesswomen, it seems, are born. But
businessmen are made.
- The influence of genes on leadership potential is weakest in boys brought up in rich,
supportive families and strongest in those raised in harsher circumstances.
- It may be a particular genetic mutation of a serotonin-receptor gene, and not the
employer’s incentives, say, that is making people happier with their work.
- Oxytocin, which is secreted by part of the brain called the hypothalamus, has been
shown to promote trust—a crucial factor in all manner of business dealings. The stress
hormone cortisol, meanwhile, affects the assessment of the time value of money.
- Testosterone is the principal male sex hormone (though women make it too). The
literature on this hormone’s behavioral effects is vast. High levels of the stuff have been
correlated with risk tolerance, creativity and the creation of new ventures. But
testosterone is principally about dominance and hierarchy.
- The greater the mismatch between testosterone and status, the less effectively a
group’s members co-operate. In addition, in men, their testosterone levels rose up when
they felt confident and with status, than when they were ashamed, for example. A
better understanding of this could explain many aspects of marketing and what makes a
successful salesman.
Reading 4: How hardwired is human behavior?

- Evolutionary psychology also explores the dynamics of the human group. People will
likely be most effective in small organizational units.
- Evolutionary psychology = Darwinism
 According to evolutionary psychology, people today still seek those traits that
made survival possible then (on the Savannah Plain during the Stone Age): an
instinct to fight furiously when threatened, for instance, and a drive to trade

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information and share secrets. Human beings are, in other words, hardwired. You
can take the person out of the Stone Age, evolutionary psychologists contend, but
you can't take the Stone Age out of the person.
 Evolutionary psychologists do not argue that all people are alike underneath. The
discipline recognizes the individual differences caused by a person's unique
genetic inheritance, as well as by personal experiences and culture.
 Understanding evolutionary psychology is useful to managers because it provides a
new and provocative way to think about human nature; it also offers a framework
for understanding why people tend to act as they do in organizational settings.
Put another way, evolutionary psychology, in identifying the aspects of human
behavior that are inborn and universal, can explain some familiar patterns.
- Natural Selection: A primer
 According to Charles Darwin’s theory, human beings were not "placed" fully
formed onto the earth. Instead, they were an evolved species, the biological
descendants of a line that stretched back through apes and back to ancient
simians. In fact, Darwin said, human beings shared a common heritage with all
other species.
 Evolution occurs in the following manner:
◦ Environmental selection → those who are “weak” do not survive
◦ Sexual selection → weak creatures are unattractive to other members of their
group because they appear weak and less likely to reproduce.
◦ *Genetic mutations → produce new variations-say that help a species thrive
and propagate will survive the process of natural selection and be passed on.
 Evolutionary psychologists use the theory of natural selection to explain the
workings of the human brain and the dynamics of the human group. If evolution
shaped the human body, they say, it also shaped the human mind.
 Why did some changes related to advanced technology and communications not
stimulated further human evolution?
◦ Humans were so scattered back then that beneficial new genetic mental
mutations could not possibly spread.
◦ No consistent new environmental pressure on people that required further
evolution.
◦ 10.000 years is insufficient time for significant genetic modifications to
become established across the population.
 The world has changed, but human beings have not.

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- Managerial Implications of Evolutionary Psychology

Thinking and feeling:
 Emotions before reason → reliance on instinct saved human lives. For human
beings, emotions are the first screen to all information received.
◦ Evolutionary psychology suggests that emotions cannot be fully suppressed.
◦ Negatives have greater power than positive messages.
 Loss aversion except when threatened
◦ Only when humans feel safe do they feel more adventurous and take more
risks. In the Stone Age, this cautious approach to loss certainly increased
human beings' chances of staying alive-and thus reproducing. Human beings in
those years, and their descendants with this genetic inheritance, would be
more likely to avoid loss.
◦ We are hardwired to avoid loss when comfortable but to scramble madly when
threatened. This happens in businesses or stock markets. “Cut your losses and
let your profits run”.
◦ People avoid risk except when threatened. Exceptionally, a small minority
avidly seeks it (Silicon Valley entrepreneurs). Some don’t even take risks when
their lives are threatened because they are way too cautious. The vast
majority of people fall in between, avoiding loss when comfortable with life
and fighting furiously when survival requires them to do so.
◦ Effective managers need to be adept at the very difficult task of framing
challenges in a way that neither threatens nor tranquilizes employees
 Confidence before realism
◦ In the Stone Age, those who believe they could survive, were strengthened
and embolden by their confidence, in addition to making them more attractive
as mates and were more likely to pass on their genes.
◦ Too much confidence is not that good though, because you neglect to see
important clues about impending disasters.
 Classification before calculus
◦ In order to make sense of a complicated universe, human beings developed
prodigious capabilities for sorting and classifying information. For example,
the distinction between poisonous and non-poisonous berries,..
◦ In alliances, for example, human beings became hardwired to stereotype
people based on very small pieces of evidence, mainly their looks and a few
readily apparent behaviors.

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◦ Whether it was sorting berries or people, both worked to the same end.
Classification made life simpler and saved time and energy.
◦ Nowadays, people sort others into in-groups and out-groups just by their looks
and actions.
 Gossip
◦ The people who chat with just the right people at just the right time often put
themselves in just the right position. In fact, it is fair to assume that human
beings have stayed alive and increased their chances of reproducing because
of such artful politicking.
◦ The interest in rumors is ingrained into human nature.
 Empathy and Mind Reading
◦ These are the building blocks of gossip → People are much more likely to hear
secrets and other information if they appear trustworthy and sympathetic.
◦ People are also programmed for friendliness → Human beings, or at least those
who survived, became adept at building peaceful social alliances and carrying
out negotiations with win-win outcomes.
◦ Empathy and friendliness are in general positive dynamics to have around the
organization. However, the bad news is that the instinct for empathy very
easily leads us to imagine that people are more similar to ourselves, as well as
more competent and trustworthy, than they really are. Further, the drive to
act friendly can make delivering bad news-about performance, for instance-
very difficult.
 Contest and display
◦ Status in tribal groups was often won in public competitions, to demonstrate
strength, success, virility...
◦ Men are forever setting up contests between themselves to see who will be
promoted, win a new account, or gain the ear of leaders.
◦ This is a sensitive territory as it gets into the inborn differences between men
and women.
- Social living → When one looks across the astonishing variety of human societies, one
repeatedly encounters common themes, dilemmas, and conflicts. These common factors
are inborn and drive many aspects of social relations today. Evolutionary psychology's
findings about the human hardwiring for social relations have implications for managers
in three areas:
 Organizational design

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◦ People survived because of their bonds with others and family (groups of
people)
◦ Human beings organize socially.
◦ Evolutionary psychologists contend that matrix forms are inherently unstable
due to the conflicting pulls toward too many centers of gravity. People are
instinctively drawn toward commitment to one community at a time, usually
the one that is closer and more familiar to them. Thus, when a modern
businessperson is asked to report both to her regional boss and to a product
manager, she is typically drawn to the regional boss because he is physically
closer to where the employee works and to what she knows best.
 Hierarchy → If managers try to eliminate status markers or if they try to get rid of
hierarchical levels, fresh variations will just spring up in their place. By all means,
status and hierarchy should be managed in a fluid and flexible way, and all
companies know by now to avoid excessively long chains of command. But
managers would do well to recognize and reward employees through status
recognition.
 Leadership
◦ Along with each person's fundamental brain circuitry, people also come with
inborn personalities. People can compensate for these underlying dispositions
with training and other forms of education, but there is little point in trying to
change deep-rooted inclinations.
◦ The implications for leadership are, first, the most important attribute for
leadership is the desire to lead. Second, the theory of inborn personality does
not mean that all people with genes for dominance make good leaders. Third
and finally, if you are born with personality traits that don't immediately lend
themselves to leadership does not mean that you cannot be a leader.
◦ The motivation to lead is the baseline requirement for competent leadership.
After that, other personality traits and managerial skills matter. They must
match the demands of the situation.
Ecological cooperation: likely relational framework among hunter gatherers

- Limited social interaction
- No technical change
- Little capital
- Trade → based on reciprocity

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- Limited specialization
- Distribution
 sharing if predominant risk is exogenous
 private property if moral hazard is important: tools, fruits
Self-control’s main problem

- Conjecture: our innate subjective discount rate is too high (it’s adapted to less stable
environments) → main function of education: to lower it.
Henrich → Can culture influence genetic evolution? Yes
Organizing change
- Assumptions in transaction cost Economics: bounded rationality and opportunity
- Solution: “farsighted contracting” by Oliver Williams → contracting with a view far
away, people will anticipate opportunism from others. It can be counterproductive.
 Use of calculative rationality ex ante to develop safeguards against ex post
opportunism.
- If often collides with instinctive “contractual heuristics” _ mainly with cheater
detectors
 Example: love and arranged marriages
- Schiophrenic (and impossible) palliative: do not explicitly safeguard in daily life, in
marriage contract, etc.
- Resistance to change → we are conservatives → even those rationally-efficient
Managing incentives
- Fehr & Falk’s survey of experiments (bonus + fee)
- Coven’s soft essay
- Rents to increase efforts in the firms → the more effort employers want, the more
rents they’ll offer to their employees → reciprocal response.
- Motivation cannot be based only on incentives if employees have discretion.
 Positive bonus
 Negative fee
- Implementing a fine is seen as and/or reveals distrust: contradiction between fine and
generosity.
 Logic from evolutionary evolution

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 Asymmetry theory
- Homo economicus → people do better because they expect repetition and thus
reciprocity.
Social approval → People contribute less in experiments when it’s anonymous.
2. Incentive management
Reading 1: How to control the world
- To control what happens around you, you need to balance the kinds of incentives to
offer.
- According to a poll, the number one motivating factor in the workplace is “recognition
and respect”, followed by “achievement and accomplishment” but we must also
consider “money”, as economies without good monetary rewards perform badly.
- Classic management analysis: do not offer bonuses unless we have good measures of
success. In other words, do not pay your mechanic for finishing the job until the car
starts.
- Some people perceive bonuses as building a powerful coalition of unfair forces (the
boss has favorite workers), yet bonuses remain a common form of compensation.
- How can we know how to get the best results given a circumstance?
 The Dirty Dishes Parable → People neglect their responsibilities (doing the
dishes, for instance). The longer they do it, the less likely that task will be done
by them.
Would using money remediate it? Probably not, because although people are
motivated by external factors (money), there are also factors internal to their
psyche (enjoyment, pride, etc). Some payments causes external motivations to
replace the internal ones (in this case, money as a bribe would work), but for
some tasks it is the internal motivations that get the job done.
When money fails because people don’t feel the obligation to do it nor contribute
to the family by doing the dishes, parents should praise her job and talents in
order to appeal her internal motivation.
People are outraged by the idea of trading everything in markets. Sometimes that
trading with money is not well perceived (pay someone by the pound to lose
weight), and that is because the very act of trading contradicts some of our most
cherished values. Buying sex is easy, but buying sex with love, can be impossible.

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 The Car Salesman Parable → If you don’t pay people, they won’t sell cars. Car
salesmen receive bonuses from the number of cars they sell and the price they
sell it to. In this case, the incentives determine how many cars get sold, because
the bonus they get depends on it. However, a need for control is necessary: the
salesman tries to get as high price as possible, but if he abuses customers, will
lose business.
 The Parking Tickets Parable → This one shows that people respond to the same
incentives in different ways.
For example, the more poorer the country, the more likely their diplomats have
received special treatment throughout their lives, and expect those privileges to
continue. Corruptions breeds subsequent irresponsibility.
Incentives matter through the medium of how a person perceives what is at stake
in the choice. You don’t only need to get the incentives right, but you also have
to know something of the value or cultures or the people you are dealing with. In
our example, Swedes are more likely to regard governments as morally legitimate
and are more likely to obey laws (pay the tickets, for instance), in contrast to
people from Chad, which has faced corruption and violence.
Every person has a different belief of what cooperation means, and this is also
influenced by their culture and the country they live in. What may be considered
acceptable in one country, may not be for another one. For example, Norwegians
find acceptable to take sick days too many often, but for a Chad resident, this
would be conceived as unbelievable or horrifying. This is what is called
“Fundamental Attribution Error” or “correspondence bias”. The error is to assume
that a single instance of individual behavior represents a deeply rooted
personality trait. Instead, the behavior is often the result of situational
influences.
We assume other people frame choices the same way we do. For the other
person, “what is at stake” is often very different from what we think is at stake.
We rationalize our disregard for the law by noting that many others do the same
and that it is otherwise impossible to get around.

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- When does each parable apply? In the car salesman parable: Motivating people when a
combination of the following condition holds:
 Offer monetary rewards when performance at a task is highly responsive to extra
effort.
◦ Pay more money for good results and people will try harder in their jobs.
Prices and rewards also boost simple memory and recall skills ((e.g., spot
typographical errors), as well as induce individuals to endure more pain.
◦ Sometimes a bigger prize doesn’t help when the activity is easy or
transparent. There simply isn’t much scope to try harder, and so the bigger
stakes have no impact.
 Offer monetary rewards when intrinsic motivation is weak.
◦ People clean their houses without expecting a reward in cash. They still do it
because of their intrinsic motivation.
◦ Good students, even if you don’t pay them money, will keep getting great
grades.
 Pay monetary rewards when receiving money for a task produces social approval.
◦ If actors earn a lot of money, they know they’ve made it in the film industry.
They feel good about the money, not ashamed. That strengthens rather than
displaces internal motivations to work hard and to work smart (rewards in
money and status).
In conclusion, we should use money to motivate when effort matters, there is

little intrinsic desire to do the job, and money boosts the recipient’s social status.
The absence of those same factors suggests a Dirty Dishes scenario.
Higher rewards might stimulate interest in the long run. But in the short run or
even in the medium run, rewards will intensify basic, ingrained mistakes.
Criminals are driven by incentives, but they look at the immediate rewards and
ignore the longer-term costs (they only rob when they need cash).
 High rewards tend to make individuals “choke”.

◦ When more is at stake, people freeze up and make bigger errors.

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◦ Stressed people tend to conform more to social opinion. They feel out of
control and so they look to groupthink and the security blanket of other
people’s approval.
Poorly applied incentives can exacerbate this feeling of helplessness and cause
those people to behave destructively or to rebel just for the sake of rebellion. In
other words, the application of punishments and rewards can make us feel like
slaves. The result is often poor performance. Everyone needs to feel that he/she
is in control of something.
Reading 2: Psychological foundations of incentives

- Interaction of 3 important human motives with economic incentives. The first two are
social in nature (human beings are social beings), while the third one originates in the
nature of certain tasks.
 The motive to reciprocate
 The desire for social approval
 The desire to work on interesting tasks
- Reciprocity and economic incentives:
Reciprocity can be viewed as a contingent social preference because depending on the
behavior of the reference person, a reciprocal agent values the principal’s material
payoff positively or negatively.
Whether an action is perceived as kind or hostile depends on the consequences and the
fairness or unfairness of the intention underlying the action.
Reciprocity is not driven by the expectation of future material benefits. It is, therefore,
fundamentally different from “cooperative” or “retaliatory” behavior in repeated
interactions. These behaviors arise because actors expect future material benefits from
their actions; in the case of reciprocity, the actor is responding to friendly or hostile
actions even if no material gains can be expected.
 Reciprocity as a source of voluntary cooperation
◦ Reciprocity induces agents to cooperate voluntarily with the principal if the
principal treats them kindly, and sometimes it is not necessary the use of
bribery or coercion into performing tasks.
◦ In public goods the existence of conditional cooperation renders the
management of the workers’ beliefs about the other workers’ effort important

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because if a conditional cooperator believes that the others shirk he will also
tend to shirk.
◦ Explicit threats create a hostile atmosphere and may even reduce the workers’
general willingness to cooperate with the rm. Managers report that the
employees themselves do not want to work together with lazy colleagues
because these colleagues do not bear their share of the burden, which is
viewed as unfair. Therefore, the ring of lazy workers is mainly used to
establish internal equity, and to prevent the unravelling of cooperation.
◦ The notion of loyalty is closely related to the notion of social preferences and,
in particular, to the notion of reciprocity because the existence of reciprocal
workers means that employers can generate loyalty by being generous to the
workers.
◦ Employers have a strong interest in recruiting employees who have favorable
preferences and whose preferences can be affected in favorable ways.
 Explicit incentives and voluntary cooperation
◦ Appealing to the workers’ generosity and trustworthiness by being generous
and, at the same time, expressing distrust by telling them that they will be
fined if they do not respond with high effort levels does not seem to go
together. They perceive the fine as hostile and an indication of distrust from
the employer.
◦ In the negative frame the total compensation in case of non-shirking is the
natural reference point and the fine focuses attention on the fact that
something will be taken away in case of shirking. In the positive frame the
base wage is the natural reference point and the bonus focuses attention on
the fact that something will be given if the desired effort is provided.
 Reciprocity as a source of economic incentives
◦ The negative side effects of the explicit incentives mentioned above do not
apply to selfish subjects because these subjects do not exhibit voluntary
cooperation.
- Social approval, social norms and economic incentives
 The relevance of social approval
◦ Approval makes us proud and happy while disapproval causes
embarrassment and shame and makes us unhappy.
◦ Minimal social contact among strangers, making individual contributions
publicly observable raises contributions to the public good substantially.

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◦ Free riding elicits extremely strong negative emotions among the other
group members.
 Social approval and economic incentives
◦ Cases in which economic rewards and punishments work in the same
direction as the approval motive. If an employee publicly receives a
bonus for good performance the employee will also often receive the
admiration of the colleagues.
◦ Free-riding causes a lot of anger among the cooperators and that this
anger is anticipated by the potential free-riders. The cooperators’ anger
will induce them to punish the free riders even if punishment is costly
for the cooperators.
◦ While cooperation unravels to extremely low levels in the absence of a
punishment opportunity, almost full cooperation can be established in
the presence of a punishment opportunity.
◦ If, the average contribution is high each individual faces high approval
incentives. Therefore, the individual will also choose a high
contribution. Likewise, if average contributions are low, the individual
faces low approval incentives and, hence, will choose a low
contribution.
◦ Explicit monetary incentives may weaken approval incentives. The
introduction of a money reward causes a fixed reduction in the approval
reward but that further increases in the monetary incentive have no
further detrimental effects on the approval reward.
◦ Paying people for their moral behavior is, therefore, a contradiction in
itself because it means that their behavior can no longer be considered
as moral. If people know that somebody engages in a moral behavior
solely because the person expects to receive social approval they
probably will no longer consider the behavior of the person as moral.
We seem to approve of moral behavior because it is not driven by
external incentives.
◦ “Man naturally desires, not only to be loved, but to be lovely; He
naturally dreads, not only to be hated, but to be hateful; He desires not
only praise, but praise-worthiness; He dreads not only blame, but
blame-worthiness”. Social approval is therefore closely related to self-
approval.

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BLOCK 2: THE ECONOMIC ORGANIZATION

3. Markets and organizations. Divisionalization
Reading 1: markets for public services
- The organization of public services
 It is much less difficult to measure the services that constitute the core of the
“welfare state,” such as health, education or pensions and other types of
insurance, than those from the private sector.
 Expense centers have an information advantage that grants them considerable
informal discretion for allocating resources internally and manipulating central
decisions on resource allocation and choice of procedure.
 Like the Public Administration, such corporations are constantly suffering from
the tendency for administrative units to grow excessively and to provide services
inefficiently to the other divisions. At root, such failures can only be remedied by
changing the incentives of the two parties:
◦ Those of the internal users, making them pay for the services they acquire
from the expense center
◦ Those of the internal suppliers, taking from them their monopoly for the
provision of such services.
- The pathology of bureaucracy → Information asymmetries → supervision and burgetary
reviews needed, because of these reasons: incentives and lack of information.
 Whether located in the public or the private sector, expense centers tend to be
chronically inclined towards oversizing and overspending as a result of:
◦ Incentives → Usually the ones responsible for the expense centers receive a
higher remuneration when the center’s budget increases (conflict of
interests).
 Lack of information available to the person in charge of controlling the activity →
difficult to establish a budget for each service at its optimal level. And, even if
they had information, it’d be difficult to determine the way it is spent.
 Crises often lead to overall cutbacks, perhaps to contain the costs generated by
the actual budgetary battle, when their effects are anyway likely to be
temporary. The problem is likely to reappear soon, because cutbacks do not solve
the root of the problem which lies in the interests of the centers and their clients

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and is aggravated by the information difficulties suffered by the person

responsible for the budgetary allocation.
- Internal competition as a solution to the problems of bureaucracy
 Users and suppliers’ incentives:
◦ The most basic requirement for motivating users so that their decisions help to
achieve better allocation of resources is that their consumption of the service
should incur a positive opportunity cost.
◦ The use of nominal prices reduces user motivation but will not necessarily
destroy it altogether, provided that such nominal prices reflect real
opportunity costs, as when users are able to obtain other services with these
resources or, at least, the same services but from different suppliers.
◦ Regarding suppliers, the most important general options are in theory
represented by the different possibilities of divisional organization of expense
centers in the form of cost centers, revenue centers, profit centers and
investment centers and even franchises. As decisions are increasingly
delegated to the center in question, the performance indicator will have to be
increasingly global.
◦ The remuneration of whoever is in charge of such a center has to be linked to
some sort of performance indicator so that they show interest in using their
resources optimally.
 The nature and costs of control → the essential characteristics are defined by
two variables: freedom and responsibility.
◦ Freedom → redistributing decision rights: decisions that were previously
centralized are delegated to users and suppliers.
Responsibility → based on some degree of horizontal and mutual control: that
exerted by users on suppliers through their purchase decisions and by suppliers
on users through their pricing policy.
◦ Reform will re-create market functioning (“internal markets”), as well as
competition changes the way in which suppliers and users allocate their
resources.
◦ An internal market is only a market in name, as there are no property rights
and all prices are administered.
- The organization of privately valuable services in the liberal state
 Solutions adopted in the 19th century in the Spanish Public Administration:
notaries, registries, and courts.

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◦ Strong user fees → Court users paid fees which financed a substantial
proportion of costs, and its elimination resulted in litigation, congestion,
rationing, etc. In contrast, both notaries and registrars are paid explicit,
regulated fees by one of the parties, and these fees finance services fully.
Both notaries and registrars have shown considerable flexibility in adapting to
drastic swings in market demand.
◦ Limited user choice → Free choice supplier is only for private services
(notaries). It is also understandable that notaries tend to be flexible regarding
the wishes of the parties, interpreting legal restrictions in the way that best
suits them. Conversely, for courts and registries, freedom of choice would
endanger their impartiality and their basic function of protecting third parties.
◦ Strong incentives to suppliers → Paying bonuses increased productivity in
court’s clerks.
◦ Role of automatic control → incentives are arranged in a way that favors
mutual control by participants. Such controls between complementary
suppliers are enhanced by using different compensation functions.
Reading 2: The Modern Firm

- Firms vs markets:
 Ronald Coase → there are costs to organizing economic activity, to achieving
coordination and motivation, and that economizing on these transaction costs
explains the patterns of organization that are adopted.

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 If arrangements are not efficient, then (by definition) it is possible to make

everyone better off. So, if an arrangement persists, there is reason to suspect
that it is efficient, at least for the parties who are in a position to have their
interests represented.
 The efficiency of actual arrangements is constrained by informational and
observational limitations.
 Transaction costs: cost of information + search + negotiation + opportunity cost.
 An asset is specialized to a particular use when the value it can create in its next-
best alternative use is substantially lower than what it yields in the current one.
 A portion of the returns to the asset are then quasirents, returns in excess of
what is needed to keep the asset in its current use once it has been created.
 Oliver Williamson (1985) has pointed to the policy of selective intervention as a
response to any inherent disabilities of the centralized, hierarchic organization of
a firm. The idea is to replicate the workings of the market within the firm
whenever this yields efficiency, while top executives intervene selectively in the
subunits and the relations among them only when this yields a better outcome
than market dealings.
 One response is that it is impossible to generate the same intensity of incentives
within a single integrated firm as when units are separately owned.
 Thus, the ownership of assets determines the payoffs the parties receive.
 Who owns the assets affects investment and thus the value created. If there are
two separate firms interacting through the market, the supplier owns the assets
and has strong incentives to invest, but the buyer’s incentives are weak. If there
is vertical integration and the buyer owns the assets, then the employee–manager
has weak investment incentives, although the buyer has strong ones. With
incomplete contracts it simply is not possible to give the same incentives to an
employee as an owner receives.
 The issue is not just offering incentives that are strong enough, but offering ones
that are appropriately balanced.
 Typically there are multiple ways that someone can spend time, many of which
might be of value to an employer. But if these activities compete for the person’s
attention,16 then the incentives offered for different activities must be
comparable. Otherwise, the person will focus disproportionate amounts of her
effort on those things that are especially well compensated and ignore the others.
The second observation is that providing strong financial incentives is costly if the

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person is risk-averse, because it loads extra risk into pay. Further, the cost is
greater the more difficult it is to measure performance. This means that, other
things being equal, tasks where performance is hard to measure should not be
given as intense incentives as ones that are more accurately observed.
 So moving an activity out of the market and into the firm increases the
opportunity for interventions, including ones that are not efficiency enhancing.
 There are a variety of methods that can be employed to limit influence activities.
One is to limit communication between executives and lower-level people. This
limits the opportunity for politicking and strategic information provision, although
it brings an obvious cost that some useful information is not transmitted.
 If salaries are completely determined by seniority and job assignment, then there
is no point in politicking for a raise. Promoting on objective measures of past
performance rather than on the apparent (i.e. less objective and more
manipulable) qualifications for the new post can be rationalized as reducing the
incentives for influence (as well as motivating current performance).
 Once it is established that there are costs to internal organization, the boundaries
of the firm are determined by the Coasian formula: Organize transactions
internally if and only if the costs of doing so are lower Nature and Purpose of the
Firm 102 than organizing through markets. We know quite a bit about market
organization.
Reading 3: Specific Knowledge and Divisional Performance Measurement

- Performance measurement includes subjective as well as objective assessments of the
performance of both individuals and subunits of an organization such as divisions or
department.
- 3 aspects of the rules of the game: performance, reward, punishment.
- cost and revenue centers → work best where headquarters has good information about
cost and demand functions, product quality and investment opportunities.
- Specific and general knowledge
 We define specific knowledge as knowledge that is costly to transfer among
agents and that is not easily observable by other agents (particularly, by
managers higher in the organization’s hierarchy). General knowledge is
information that is transferable among agents at low cost or is easily observable
by other agents.

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 The alternative to moving the knowledge is to move the decision rights to those
agents who possess the relevant specific knowledge. But even though
decentralization has the potential to improve decision-making, it is not without
costs of its own. The costs incurred are those that arise from the potential
conflict between the private interests of managers and employees and the goals
of the organization.
 Agency costs → the costs of devising and enforcing contracts with agents; the
costs of monitoring the agents’ behavior; the bonding costs incurred by the agent
to help assure the principal that he or she will not engage in opportunistic
behavior; and, finally, the “residual loss”.
- Alternative divisional performance measures (5 performance measurement):
 Cost centers
◦ Cost centers are designed to encourage managers to focus on increasing the
efficiency of the production process without the distractions caused by
changes in demand conditions that would affect them if revenues were
included in the performance measure.
◦ 1. Minimize costs for given output.
2. Maximize output for given total cost.
3. Minimize average costs (with no quantity constraint) → inefficient because
it motivates the cost center manager to achieve a level of output that
minimizes average cost.
◦ The advantages of this system, when it can be implemented, come from the
specialization it encourages. As we noted above, the cost center manager can
focus on increasing the efficiency of the production process without the
distractions caused by changes in demand conditions.
◦ In sum, cost centers will tend to be the most efficient performance
measurement system when the optimal quantity, quality, and product mix
decisions can confidently be made outside the division. But, when it is difficult
to measure quantity and quality, and when the knowledge required to make
the optimal quantity, quality, and product mix decisions is specific and
inaccessible to those higher in the hierarchy, it will be difficult to operate the
division as a cost center. In such cases, as discussed later, profit or investment
centers are likely to work better.
 Revenue centers

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◦ Revenue centers have essentially the same advantages as cost centers—the

greater focus and inducement to specialization associated with greater
controllability. But they also have similar problems, and thus limitations on
their effectiveness, stemming from lack of specific knowledge at
headquarters.
◦ 1. Maximize total revenues for a given price.
2. Maximize total revenues for a given quantity of unit sales.
3. Maximize total revenues (with no quantity constraint).
◦ The advantage of the revenue center is that the manager can specialize in the
marketing and sales effort without concern for the factors that influence
production cost. To do so the manager will generally be given decision rights
over marketing and sales issues that require considerable specific knowledge
(available only at the local level), but not the right to decide on quantity or
product mix.
◦ This means that, when the knowledge required to make the quantity and
product mix decision is available at low cost at higher levels in the hierarchy,
the revenue center structure will tend to be efficient.
 Profit Centers
◦ We use the term here to describe a system in which a division’s performance is
measured by its profits.
◦ Nevertheless, the profit center structure also has potentially serious problems
of its own. It is well known that maximization of profits for each division does
not lead to maximum profits for the firm as a whole, except in the special
circumstance in which there are no interdependencies between divisions. Such
interdependencies can take the form of:
▪ Interfirm transactions → in which one or more divisions buys the product of
another, and therefore the price paid by the buying division affects its
costs and pricing decisions (the “transfer pricing” problem).
▪ Interdependent demands → (e.g., Pontiac and Oldsmobile, or film and
cameras), where demand for one or more of the firm’s products depends
on the policies for the other products (e.g., pricing, quality, or technology)
▪ Interdependent supply or cost functions → where the cost of producing a
product depends on the production decisions for other products (e.g.,
gasoline and kerosene, since more gasoline production means less kerosene
obtained from a barrel of crude oil)

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 Investment centers (ROE/ROA) and EVA (Economic Value Added ~ Residual

income)
◦ The manager is evaluated on some measure that relates profits to the assets
(and underlying capital) used to generate them.
◦ EVA is defined as net cash flow in a period less a capital charge equal to the
cost of capital times the dollar value of the assets employed in the business.
 Expense centers
◦ A division organized as an expense center generally produces services for the
rest of the organization, and the consuming units are not charged for the
services they consume.
- Internal Chargeback Systems: Decentralizing Part of The Control Function
 Consumers have no incentives to compare the cost of the services they consume with
the value of the services to them.
- Choice of performance measure
 The decision to operate a division as an expense center is in large part a decision
to control and monitor the division directly from higher in the hierarchy. This
centralized control and monitoring option will be more attractive when it is easier
to evaluate the performance of the division from higher levels of the hierarchy,
and when it is difficult to decentralize the monitoring function to users of the
output of the division.
 In general, a cost center will be more desirable the lower is the cost of obtaining
good information about:
◦ quantity
◦ quality
◦ correct output mix
◦ cost functions.
 Profit centers will tend to be more desirable when the above costs are high and
when:
◦ the correct revenues for the division are relatively easy to identify
◦ there are few interdependencies in cost and demand functions between
divisions
◦ there are no major internal monopoly problems. In cases of business units that
provide product or services mainly to other units inside the firm, profit centers
will tend to work best when they are combined with a decision rights

lOMoARcPSD|10634923
assignment that decentralizes part of the monitoring function of the center to

its customers through a chargeback system.
It is important, however, that such chargeback systems give those customers
effective alternatives and thereby provide potential or actual competition for
the profit center. Investment centers and EVA will tend to be more desirable
when the activity is capital-intensive and when it is difficult to identify
optimal divisional asset investments from higher in the hierarchy.
4. Markets vs politics
Reading 1: Frank, microeconomics and behavior, Ch. 16 on externalities
- Negotiations are often costly. When they are, it matters very much indeed which legal
regime we choose.
- The costs of negotiation sometimes stand in the way even of agreements that would
substantially benefit both parties.
- Efficient laws and social institutions are the ones that place the burden of adjustment
to externalities on those who can accomplish it at least cost → One of the immediate
implications of this rule is that the best laws regarding harmful effects cannot be
identified unless we know something about how much it costs different parties to avoid
harmful effects.
Reading 2: The use of knowledge in society

- Knowledge never exists in concentrated or integrated form, but solely as the dispersed
bits of incomplete and frequently contradictory knowledge which all the separate
individuals possess. Economic problem of society is of the utilization of knowledge not
given to anyone in its totality.
- Misconception about the economic problem: due to an erroneous transfer to social
phenomena of the habits of thought we have developed in dealing with the phenomena
of nature.
- “Planning” is the word used to described the complex of interrelated decisions about
the allocation of our available resources. In society, this planning is given to somebody
different than the planner, and he/she will have to covey it to the planner.
- Planning means central planning: direction of the while economic system according to
one unified plan. Competition means decentralized planning by many separate persons.
The in-between is the delegation of planning to organized industries (aka, monopoly).

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- Scientific knowledge is as important as unorganized knowledge (knowledge of the

particular circumstances of time and place).
- We need decentralization because only this can we ensure that the knowledge of the
particular circumstances of time and place will be promptly used. But the “man on the
spot (the central planner) cannot decide only with his limited but intimate knowledge of
the facts of his immediate surroundings.
- In a system where the knowledge of the relevant facts is dispersed among many
people, prices can act to coordinate the separate actions of different people in the
same way as subjective values help the individual to coordinate the parts of his plan,
Reading 3: The Problem of Social Cost

- We are dealing with a problem of a reciprocal nature. The problem is to avoid a more
serious harm.
- The pricing system with no liability for damage
 Although the pricing system is assumed to work smoothly (that is, costlessly), the
damaging business is not liable for any of the damage which it causes. This
business does not have to make a payment to those damaged by its actions. I
propose to show that the allocation of resources will be the same in this case as it
was when the damaging business was liable for damage caused.
- With costless market transactions, the decision of the courts concerning liability for
damage would be without effect on the allocation of resources.
- Judges have to decide on legal liability but this should not confuse economists about
the nature of the economic problem involved.
- If we are to attain an optimum allocation of resources, it is therefore desirable that
both parties should take the harmful effect (the nuisance) into account in deciding on
their course of action. It is one of the beauties of a smoothly operating pricing system
that, as has already been explained, the fall in the value of production due to the
harmful effect would be a cost for both parties.
- This doctrine states "that if a legal right is proved to have existed and been exercised
for a number of years the law ought to presume that it had a legal origin.
- The reasoning employed by the courts in determining legal rights will often seem
strange to an economist because many of the factors on which the decision turns are, to
an economist, irrelevant. Because of this, situations which are, from an economic point
of view, identical will be treated quite differently by the courts. The economic problem
in all cases of harmful effects is how to maximise the value of production.

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- Once the costs of carrying out market transactions are taken into account it is clear
that such a rearrangement of rights will only be undertaken when the increase in the
value of production consequent upon the rearrangement is greater than the costs which
would be involved in bringing it about. When it is less, the granting of an injunction (or
the knowledge that it would be granted) or the liability to pay damages may result in an
activity being discontinuled (or may prevent its being started) which would be
undertaken if market transactions were costless.
BLOCK 3: THE INSTITUTIONAL ENVIRONMENT

5. Institutional support of private contracting
Reading 1: Contracts of Adhesion
- When the terms in a standard-form contract are uniform, sellers do not compete over
them. Narrowing the scope of competition can reduce its intensity.
- Contracts of adhesion justified to: reduce competition. Unjustified: To increase the
efficiency of exchange.
- Standard-form contracts can:
 Promote price competition by reducing product differentiation, as this
complicates price comparisons.
 Reduce transaction costs → they can move a market closer to the perfectly
competitive ideal by reducing transaction costs.
- Because standard-form contracts can increase competition and efficiency in exchange,
the phrase “contract of adhesion” should not be applied to standard-form contracts.
Rather, the phrase should be reserved for monopoly contracts. The relevant question is
whether a market is competitive or monopolistic. The fact that a contract was made on
a standard form does not establish a presumption in either direction.
- The non-price terms of a contract typically create incentives that affect the size of the
surplus from exhchange. In contrast, the price terms typically distribute the surplus
between the parties. In brief, a monopolist who can extract all of the surplus from each
exchange by controlling the price will choose efficient non-price terms.
- Contract of adhesion used as a term when a seller takes advantage over a buyer’s
ignorance (he forgot to read the terms or he/she does not appreciate the term’s
significance).
- If buyers are informed and markets are competitive, the standardized terms in form
contracts will be efficient, not biased against buyers, without any bargaining. The real

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problem with this kind of contract is the buyer’s ignorance, not he absence of
bargaining.
Reading 2: The role of institutions in the contractual process

- Human beings increase their productivity by specializing their resources and
exchanging their products. The organization of exchange is costly, however, because
specialized activities need coordination and incentives have to be aligned.
- In all contractual processes, exchanges have to be completed and enforced, however
problems arise because there is informational asymmetry between the parties,
prompting opportunistic behavior.
- 4 types of contractual completion result:
 Explicit contracts
 Normative system
 Relational contracts (capable of solving unforeseen situations)
 judicial system
- Different enforcement mechanisms require different degrees of observability with
respect to performance:
 First-party enforcement → it is the individual in breach who will evaluate and
sanction his own conduct. Evaluation takes place in relation to his own moral
code and the sanction consists of a certain psychological suffering which takes
different forms, related to religious conviction and self-esteem.
 Second-party enforcement → based on verification and sanction by the party
suffering the consequences of breach, who may break off the relationship with
the other party or appropriate some hostage or security.
 Third-party enforcement → requires 4 verification by third parties. It comprises
centralized systems, such as arbitrators and judges, and decentralized systems.
- Virtually all private ex post completion is subordinated to the judicial system, so that
it is generally impossible for the parties to deprive themselves ex ante of the (not
always desirable) possibility of appealing against their decisions ex post. For these
reasons, rather than complementarity among solutions, there is now interference, with
institutional solutions reducing the scope of individual solutions.
- In the private field it may be thought that the more the contract is completed ex ante,
the less it is necessary to complete it ex post. However, the functioning of ex post
decision-making bodies and rules makes it more necessary to devote resources to ex
ante completion, at least to provide for the basic elements of 5 such bodies and rules. In

lOMoARcPSD|10634923
the institutional field, there is a particular interaction: to the extent that litigation
leads to case law, ex ante completion is developed to a greater extent and can be
expected to reduce recourse to litigation.
Ex ante legal completion

- When it takes place in an institutional environment of a legal nature, exchanges are
carried out in accordance with a very extensive contract, even though the parties
themselves only expressly agree on the most basic elements of the exchange. the cost of
writing contracts defining the content of the exchange is reduced because contracts are
written in an institutional framework established by the law and ancillary institutions,
not in a direct one-to-one relationship between the parties. → rationalization
mechanism.
- The rationality of the parties is bounded when contracting since the contract is not
usually of sufficient scope and the parties are not usually in a position where it is
worthwhile devoting the necessary resources to completing it, not even to the extent of
defining the content of the exchange in a series of likely contingencies. This limitation
relates to the intellectual rationality of the parties and is a direct consequence of
individual mental activity. By settling for the law, the parties opt to base completion of
the contract on rationality of an evolutionary type, which has generated the greater and
more durable part of the law. The parties can thus contract in ignorance, without
knowing details of the content of their rights and obligations, trusting in the efficiency
and good sense of their legal definition.
- 2 sources to consider in legal completion:
 Customary law → more important in the common law tradition → mixture of
evolutionary and intellectual rationality.
 Statutory law → more important in the civil law tradition
- Particular forms of legal completion may serve other purposes. For instance,
codification has been used to prevent judicial opportunism by restricting the discretion
of the courts.
- Facilitating or enabling rules can be modified at the will of the parties when they state
as much in the contract. They thus fit fully into the efficient argument, since their
purpose is to reduce the cost of contracting, providing the parties with a standardized
solution to the most typical or common problems that arise with different types of
contract. On the other hand, mandatory rules are binding on the parties who cannot
modify or exclude them. Their existence can be justified by failings in free contracting,

lOMoARcPSD|10634923
whether such failings lie in the presence of external effects or in the irrationality of the
contracting parties.
- A function of the law is to prevent the parties from having to manifest their desire to
include a particular clause in the formal contract. Likewise, proposing a clause that
varies from the provisions of the enabling legal rule could be interpreted as a sign of the
problematical contractual characteristics presented by the proposer.
- The general consequence of inefficient mandatory rules is to raise contractual costs.
This makes specialization impossible or forces parties to use suboptimal arrangements.
- Failings also occur in the legal system as a result of insufficient introduction of laws.
- Both shortcomings increase demand for their services to the extent that they facilitate
ex ante contracting, which is complementary to mandatory laws and substitutive of
facilitating laws.
- The judicial system carries out an enforcement task, not only explicitly, by
implementing its decisions or judgments, but also implicitly, by encouraging voluntary
compliance in anticipation of an even more costly judicial decision.
- 3 specific types of failure in the judicial system:
 deficient identification of judicial opportunism by the parties → The existence of
the judge thus motivates the parties to devote resources to both bringing about
and preventing this manipulation.
 defective consideration of criteria of “material justice” → this type of judgment
motivates judicial opportunism by the parties, who will try and place themselves
in a position in which justice will favor them.
 the presence of a possible bias against quasi-judicial action by the parties → the
ex post contractual asymmetry tends to be perceived by some judges as unfair
and they therefore tend to correct it, thus inefficiently restricting the quasi-
judicial powers which the private contract itself allocates to one of the parties.
- It is also important to take account of the biases that the market may suffer when
judging the activities of its participants, particularly when property rights in relation to
reputation are poorly protected against opportunistic attack.
- One of the essential functions of the institution we call the “market”, that of acting as
judge, rewarding and punishing the conduct of those involved in it.
- in some cases the person monitoring or bonding third party activities is a specialist,
generally a firm, which charges for its services. In other cases, it is the market itself, as
in the case of the market for corporate control, whose activities protect the relationship

lOMoARcPSD|10634923
between shareholders and directors of all companies with specialized ownership and
control, not only those directly affected.
- Reputational assets may be subject to a certain degree of expropriation through
“reputational blackmail”.
Conclusions
- Laws improve individual parties’ rationality, courts complete and enforce contracts,
and markets motivate contractual performance.
- Public intervention is decisive in making these institutions more or less effective in
their facilitating roles.
- Finally, market enforcement is based on reputational assets that are exposed to
opportunism
6. Role of business firms in society

Reading 1: Serving Shareholders Doesn’t Mean Putting Profit Above All Else
- Companies should maximize shareholder welfare, not value. Our starting point is that
shareholders care about more than just money. The are prosocial because they are, at
least to some degree, about the health of society at large.
- New mantra in Europe, is ESG: Companies should care about the environmental and
social impact of their investments.
- How can boards incorporate shareholder welfare? The article proposes through a
referendum to elicit shareholders’ preferences. It would make corporations more
democratic, not less, by elevating the social concerns of the millions of present and
future pensioners. Finally, by restricting shareholder concerns to pure profit, we’re not
simply leaving values to the realm of politics; in practice, we’re often declining to
consider those values at all.
- To a casual observer, the difference between shareholder welfare and shareholder
value might seem small. Yet it is on the basis of the shareholder value principle that
corporate boards and courts of law reject the ability of shareholders to influence
corporate policy on social issues that shareholders care about.
Reading 2: Social Responsibility and economic efficiency

- A firm affects others by competing with them in the product markets and in the factor
markets, in the buying of labor, buying of other goods for its use, and in the selling of its
products.

lOMoARcPSD|10634923
- Firms ought to maximize their profits: what they buy they pay for and therefore they
are paying for whatever costs they impose upon others. What they receive in payment
by selling their goods, they receive because the purchaser considers it worthwhile. This
is a world of voluntary contracts.
- Profit really represents the net contribution that the firm makes to the social good,
and therefore, profits have to be as large as possible.
- The forces of competition prevent the firms from engrossing too large a share of the
social benefit.
- Quality reduction is a net social benefit, if the saving in cost is worth more to the
consumer than the quality reduction.
- Under the proper assumptions profit maximization is indeed efficient.
Problems/effects of profit maximization:
 The forces of competition are sufficiently vigorous. But there is no social
justification for profit maximization by monopolies.
 The distribution of income that results from unrestrained profit maximization is
very unequal.
 It tends to point away from the expression of altruistic motives. These motives
are motives whose gratification is just as legitimate as selfish motives, and the
expression of those motives is something we probably wish to encourage.
- Making profits by competition is to be encouraged.
- 2 categories of effects where the arguments for profit maximization break down:
 pollution or congestion → the firm does not pay for the harm it imposes on others,
and it will pollute more than is desirable.
 There are quality effects about which the firm knows more than the buyer → loss
of consumer satisfaction imposed by the failure to convey information that is
available to the seller. Even if the consumers are cheated (or not), there’s still an
efficiency. If one could arrange to transmit the truth from the sellers to the
buyers, the efficiency of the market would be greatly improved.
- Profit maximization can lead to consequences which are clearly socially injurious.
- If a firm has some code imposed from the outside, there is some expectation that
other firms will obey it too and therefore there is some assurance that it need not fear
excessive cost to its good behavior. But there are some alternative kinds of institutions:
 Legal regulations
 Taxes
 Legal liability

lOMoARcPSD|10634923
 Ethical codes → only useful when widely accepted. Its implications for specific
behavior must be moderately clear, and above all it must be clearly perceived
that the acceptance of these ethical obligations by everybody does involve mutual
gain.
- I would not want the firm to act in accordance with some ethical principles in regard
to matters of which it has little knowledge.
Reading 3: The social responsibility of business is to increase its profits

- In a free-enterprise, private-property system, a corporate executive is an employee of
the owners of the business. He has direct responsibility to his employers. That responsi-
bility is to conduct the business in accordance with their desires, which generally will be
to make as much money as possible while conforming to the basic rules of the society,
both those embodied in law and those embodied in ethical custom. Of course, in some
cases his employers may have a different objective.
- On the level of political principle, the imposition of taxes and the expenditure of tax
proceeds are governmental functions. We have a system of checks and balances to
separate the legislative function of imposing taxes and enacting expenditures from the
executive function of collecting taxes and administering expenditure programs and from
the judicial function of mediating disputes and interpreting the law.
- The difficulty of exercising "social responsibility" illustrates, of course, the great virtue
of private competitive enterprise–it forces people to be responsible for their own actions
and makes it difficult for them to "exploit" other people for either selfish or unselfish
purposes. They can do good–but only at their own expense.
- He calls from many businessmen for wage and price guidelines or controls or income
policies. There is nothing that could do more in a brief period to destroy a market
system and replace it by a centrally controlled system than effective governmental
control of prices and wages.
- The political principle that underlies the market mechanism is unanimity. In an ideal
free market resting on private property, no individual can coerce any other, all
cooperation is voluntary, all parties to such cooperation benefit or they need not
participate. There are no values, no "social" responsibilities in any sense other than the
shared values and responsibilities of individuals. Society is a collection of individuals and
of the various groups they voluntarily form.
- The political principle that underlies the political mechanism is conformity. The
individual must serve a more general social interest–whether that be determined by a

lOMoARcPSD|10634923
church or a dictator or a majority. The individual may have a vote and say in what is to
be done, but if he is overruled, he must conform. It is appropriate for some to require
others to contribute to a general social purpose whether they wish to or not.
- Unfortunately, unanimity is not always feasible. There are some respects in which
conformity appears unavoidable, so I do not see how one can avoid the use of the
political mechanism altogether
Reading 4:

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Notes taken from the readings and powerpoint presentation at

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Economic Organizations, Institutions and

CASE BASED INTRODUCTION

0. Linking Business Economics and Organizations and Markets through

TAXIS: What do we see?

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 VTCs complain on barriers of entry.

Quality is an important variable to take into consideration, because sometimes it may

Taxi production structure

- Pure market: Possible failures?

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- How does it work?

Case 2. Public bureaucracy

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Public bureaucracies: what do we see? What have you read?

- Do we need public bureaucracies?

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- How do they compare with private firms?

What is the production structure of public bureaucracies?

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In private sectors, there is a trade-off (price-quality; depending on the quality,

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- Divisional objectives vs firms objectives

Case 3. Corporate Social Responsibility (CSR), or Environmental, Social & Governance

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Corporate Social Responsibility (CSR). How do people feel about firms?

What do we mean by making firms “responsible”?

- Legally liable: e.g.:

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- Maximizing shareholders’ wealth vs welfare.

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- Managing fashionable concepts: E.g: CSR → ESG

BLOCK 1: INDIVIDUAL BEHAVIOR

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- A benign environment is one where individuals rely on System 1, whereas in a hostile

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Why individuals behavior?

Key dimensions in human conduct

Business economics: Prospect theory (asymmetric value function)

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The dual systems in our brain:

Irrelevant options (“The Decoy Effect”) “señuelo”, “engaño”

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How we succeed in being cognitive specialists

Reading 2: Human Nature and institutional analysis

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to have developed specialized innate abilities to detect cheating behavior, as well

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 Institutions as complements of human nature → Filling the adaptation gap

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◦ In the interest of who? E.g.: the selfish gene?

Instinctive rationality is better than rational

Instinctive cooperation (1): Lack of facial control helps us trading

Reading 3: Homo administrans

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Reading 4: How hardwired is human behavior?

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- Managerial Implications of Evolutionary Psychology