Something that suggests that the size of the firm should be limited is specialisation. If the costs of buying in the product for firm 1 are less than the actual costs of making the product, then it should be left to the other firm 2 to make this product which it specialises in, and firm 1 to buy it. For example, take the household as a firm 1 and a bakery as firm 2. It is more efficient for the household to buy in bread from the bakery, as the transactions costs are less than the cost of a bread maker, and the time and ingredients put into making the bread
F, A, G p270-272 management economics book
Teamwork occurs when an output is produced by the simultaneous cooperation of several team members to perform tasks. This cooperation reduces transactions costs. However, it can create other costs within the firm, such as shirking.
Teamwork can cause, for the selfish individual, incentive to shirk, due to 2 related reasons. Firstly, it is difficult for the manager or principle to distinguish between the marginal products of each worker and detect which worker is shirking, and so production units within each team tend to be paid the same rate. Secondly, the shirker reaps benefits from his shirking, whereas the other team members bear the costs. The dilemma posed in providing motivation in these situations is termed the incentive problem. In the absence of perfect and cost-free monitoring, each team member can rationally be expected to shirk and hope to free ride on the efforts of other members.
Another problem is that the productivity of any one-team member depends crucially on the input provided by other members. So if one team member shirks, the marginal product of the others, as well has total product of the team will fall.
Giving employees some property rights, and a cut of the profits, through partnerships, or making the manager the residual claimant can reduce the incentive problem.
1 Partnerships often exist where set-up costs are low, and where quality of production is difficult to observe, in markets such as accountancy, law and architecture.
- The residual claimant should be the monitor, so he has incentives to increase profits. He should be a capitalist as they are more able to bear risk; workers bear no risk and always get the same wage. Although most property rights are in the hands of capitalists, some may be owned by labour in the form of cooperates.
The state interferes with property rights:
- Uses zoning and planning permission, which weaken property rights
- Takes a stand on fair dismissal, racial discriminations, affecting capitalists hiring and firing.
As a positive, teamwork, however can instil a feeling of collective well being, encouraging individuals not to shirk, and the firm to further reap the benefit from this increase in cooperation within the firm.
P218-220
The divorce between ownership and management: is an example of principle agent theory, where the owners are the principle and they hire managers (agents) to run the firm. The firm is owned by thousands of stockholders, most of whom have nothing to do with the running of the firm. A professional management team makes the decisions. Of course, some managers may own stock, but many do not. The problem lies where owners and managers are two completely separate groups, perhaps with strongly differing goals. The owners of the firm have a claim on the profit of the firm, hence want the firm to maximise profits. The managers, however, have goals beyond profit maximisation. Their goals may involve personal objectives. They are thought to act with discretion, and to have gain utility from a balance of profit maximisation and personal gain. The personal objectives include
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Consumption of leisure. ‘On the job leisure’. Managers slack while no one is looking, or enjoy three martinis on a ‘business’ lunch. This would cause profits (goal of owners) to suffer.
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Amenity Maximisation. Williamson 1964- Suggestion managers derive utility from big offices, many subordinate workers and expensive meals. Profit maximisation should be separated from amenity maximisation. Is a private jet for an executive profit maximising, as his time is so precious or is it just an executive toy?
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Sales maximisation: Prestige of a manager can be linked to sales maximisation. Objective of manager is revenue maximisation so he produces at Xr, where owners objectives of profit maximisation would cause production to be at Xp. Therefore, overproduction of Xp Xr occurs, and profit loss of the triangle abc.
Pounds per unit
Of output b
MC
MR a
c
Xp Xr
Units of output per year
Two sorts of mechanisms for monitoring managers, Internal and external.
- Internal see K& R. They consist of corporate government schemes, involving using the pay mechanism as an incentive to performance. This is a way of persuading managers to represent the interests of owners.
- Externally managers are forced to behave competitively by the stockmarket, which provides the threat of takeover bid. 50-75% of managers lose their jobs within two years of a takeover. The market is a mechanism to force managers to maximise profits.
Conclusion
Firms are created to reduce transactions costs which occur in the market. However, there are other costs created by the structure of the firm, such as asymmetric information, and differing goals of different members of the firm. These are seen through examining teamwork in a firm, where workers have incentive to shirk, and through the problem with divorce between ownership and management, where goals of the principle and agent can differ. Both of these problems arise due to asymmetric information within the firm, and cause moral hazard.