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What is the importance for the theory of the firm of transaction costs, teamwork and the divorce between ownership and management?

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1. What is the importance for the theory of the firm of transaction costs, teamwork and the divorce between ownership and management? K&R 198, 220 Workshop 4 PLAN: Introduction Explain relevance to theory of the firm including definitions of Transaction costs, teamwork, divorce between ownership and control. What can firm do to counteract problems arising involving these factors. Conclusion P198-199 Transaction Costs: cost of conducting an economic exchange between two parties. Transaction costs have two important implications for the theory of the firm; firstly the theory of transaction costs predicts that economic exchange will tend to be organized in ways that minimize the costs of those exchanges (explaining the very existence of the firm), secondly transaction costs play an considerable role in limiting the size of firms. Coase wrote in 1937 that Economic exchange will tend to be organised in ways that minimize the cost of exchanges. One way to do this is to offer general contracts. If firms do not have general contracts, an employee cannot be asked to perform beyond his specific task- limiting the size of the firm. The firm, by offering general contracts, can minimize transaction costs. The firm may be described as a tool to minimise transactions costs. ...read more.


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. 2 The residual claimant should be the monitor, so he has incentives to increase profits. ...read more.


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. 1 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. 2 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. ...read more.

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