Managerial Economics Organizational Architecture

							Managerial Economics: Today’s Agenda

•Organizational Architecture
  •Kodak Case, P. 298
•Ethics and Organizational Architecture
  •Recycling Corporate Responsibility, WSJ
  •Giving Until it Hurts, WSJ
  •Nordstrom
 The fundamental problem within firms
       Knowledge and Incentives
• Profit maximization may face information
  limitations
  – controlled by many individuals
  – may be costly to transfer
• Individuals may have incompatible
  incentives
• Organizational architecture must overcome
  these limitations
Basic Tenets of Economic Approach to Organizations

• Self interest
   – Of employees, managers, even CEOs
   – Present to some extent
• Architecture influences behavior
   – Behavior shaped by incentives
• Implications for increasing value
   – Balance the 3-legged stool
   – Decision makers need specific knowledge to make
     appropriate decisions and the incentives to use the
     information productively
            Components of architecture
               “three legs of the stool”
• Decision-right assignment
   – empowering employees
   – who makes what decisions in
     organization
       • What knowledge/information does
         the decision maker have access to?
• Reward system
   – compensating employees
       • Pecuniary; non-pecuniary
   – sets incentives
• Performance-evaluation system
   – evaluating employees
   – accountability
Determinants of
Organizational
Architecture

Goals:
· link decision rights with knowledge
· motive agents to make productive
decisions based on their information.
 · Reward value-enhancing decisions
            Corporate culture

• Culture is the set of explicit and implicit
  expectations of behavior within the firm
• Culture includes formal organizational
  architecture
• Communicating culture
  – slogans, rituals, role models
         Case Analysis Questions
• Does the strategy fit the business environment and
  capabilities of the firm?
• What are key features of the current architecture?
• Does the current architecture fit the business
  environment and strategy? Does it link specific
  knowledge & decision rights and provide incentives
  to use info productively?
• Are 3 legs of stool mutually consistent?
• If problems, what changes in strategy & architecture
  should firm consider?
• What problems in implementing changes?
        When architecture fails

• Management is at risk of dismissal
• Firm is at risk of takeover
• Rivals are lurking in the wings

• Can you say Enron???
         Changing architecture
• Benefits of organizational change must
  exceed costs
• Costs
  – direct: resources for design and communication
  – indirect: short-timer effect on human capital
    development
• Organizations are interdependent systems,
  change must be coordinated
       Managerial implications

• Consultant advice should be examined
  closely
  – e.g., employee empowerment may not always
    be appropriate
• Effective benchmarking requires
  architectural awareness
      Discussion Question
• What is a major difference between the
  organizational architectures of markets
  and firms?
Evaluate this organizational architecture

 • Decision rights – pricing decision rights are
   assigned to the sales associate
 • Evaluation – the metric is sales volume per
   quarter
 • Compensation – flat salary plus commission
   tied to sales volume
      Eastman Kodak, p. 298
• What factors motivated Kodak to change its
  organizational architecture?
• What mistakes did Kodak make in changing
  its architecture?
• What might it have done differently?
• How does this relate to the concept of
  economic Darwinism?
Ethics and organizational architecture
Chapter 22

What is the Social Responsibility of Corporate Management?




     Karen Kozlowski (second      Before Indictment
     from left) with friend and   Dennis and Karen Kozlowski
     two models dressed as        with two models dressed as
     Roman centurions             Roman centurions
               Ethical Conflicts
• Individuals versus Legal Fictions
• Principles and Agents
  – Patients and doctors
  – Client and attorney
  – God and people
• Shareholders versus Stakeholders
  – What is a stakeholder?
     • Customers, employees, owners, suppliers,
       competitors, communities?
        – Caux Round Table
     • Animals, managers, trees, non-sentient things
        – Business Ethics literature
    Friedman on Social Responsibility of Managers

•    “…there is one and only one social
     responsibility of business – to use its
     resources and engage in activities
     designed to increase its profits so long as
     it stays within the rules of the game,
     which is to say, engages in open and free
     competition, without deception or fraud”.
    –   Milton Friedman
    “Corporate Social Responsibility”
“The solution lies in business practices that reflect
and respect the competing claims for all stakeholder
groups. No longer simply a matter of publicity or
philanthropy, socially responsible business practices
affect all aspects of business operations and
contribute significantly to corporate productivity and
profitability.”
   -Website of Business for Social Responsibility:
   www.bsr.org
  How do we get ethical behavior?

• Altering preferences?   
• Altering incentives!    
• Distinguish between policies designed to
  alter preferences and those designed to
  alter incentives
Recycling Corporate Responsibility, WSJ
• What is the author’s opinion about the
  opportunity costs of the stakeholder
  approach?
• What is the author’s opinion about Enron?
  Arthur Anderson
• What is the author’s prescription?
         Giving Until it Hurts, WSJ
–   What was Berkshire Hathaway’s policy on corporate giving?
    •   What were the key differences between A and B shares?
–   Was Berkshire Hathaway ethical? Was Warren Buffett
    ethical?
–   What problem identified in this editorial lead to a change in
    the policy?
–   Identify company’s solution and add recommendations of
    your own if you have any. It would be unusual NOT to have
    differences of opinion in your group in regard to these issues.
    You may wish to acknowledge these differences with a list of
    several alternative solutions.
–   Should corporations ever give to charity? Always give to
    charity?
–   Who should control decision rights concerning corporate
    philanthropy?
             Discussion: Nordstrom
• What is the causes of the problems described in
  this case? Is the three-legged stool balanced?
• Are Nordstrom employees pressured
  inappropriately by the sales-per-hour system? By
  management?
• How effective is the memo (Exhibit 3) in
  clarifying the distinction between “sell’ and “non-
  sell” time?
• How would you change management systems at
  Nordstrom?
• Would proposed changes in overtime eligibility
  benefit Nordstrom? Your firm? Workers?
                   Ethics Summary
• The term ethics has many different meanings which can
  change across cultures and time.
• If a corporation is to survive in a competitive environment,
  it must maximize value. Taking care of corporate
  “stakeholders,” such as employees and local communities
  can be important, but such care can only be taken so far.
• Private markets provide strong incentives for ethical
  behavior by imposing substantial costs on institutions and
  individuals that depart form accepted social standards.
• Some corporations misplace considerable effort in trying to
  change employees’ preferences through corporate ethics
  programs. The economic view, instead, takes the
  employees’ preferences as given and focuses on incentives.
             Looking Forward
• November 11 -8:00pm OEC Auditorium
  – “Tax Policy and the Economy”
  – Professor Joel Slemrod, University of Michigan
  – Optional for Monday and Tuesday Sections
• November 15 and 16
  – Managerial Economics Chapters 12 and 13
  – Decision Rights
  – Medford University, p. 325
• Assignment 4: Due November 11, 15, and 16
    Additional Ethics References
• “The Social Responsibility of Corporate
  Management: A Classical Critique” by
  Coelho, McClure, and Spry (Friedman
  paradigm)
• “A Response to The Social Responsibility of
  Corporate Management: A Classical
  Critique” by Post (Corporate Social
  Responsibility paradigm)
• Mid-American Journal of Business, Vol. 18,
  No. 1 2003 at the following website:
• http://www.bsu.edu/web/majb/