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BSZ_IM_Ch10_4e - Managerial Economics and Organizational...

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Managerial Economics and Organizational Architecture Instructor’s Manual Part 1: Chapter Overview and Solutions Chapter 10: Page 1 CHAPTER 10 I NCENTIVE C ONFLICTS AND C ONTRACTS This chapter provides an overview of incentive conflicts and contracting within firms. It begins by defining the firm as a focal point for a set of contracts. It then discusses the many incentive conflicts that exist between the parties that make up the firm. The role of contracts in reducing these conflicts is examined. The importance of asymmetric information in limiting the ability to solve these problems in a costless manner is stressed. Both postcontractual and precontractual information problems are examined. The role of implicit contracts and reputational concerns in reducing incentive conflicts is discussed. C HAPTER O UTLINE F IRMS I NCENTIVE C ONFLICTS IN F IRMS Owner-Manager Conflicts Other Conflicts C ONTROLLING I NCENTIVE P ROBLEMS THROUGH C ONTRACTS Costless Contracting Costly Contracting and Asymmetric Information Postcontractual Information Problems Precontractual Information Problems I MPLICIT C ONTRACTS AND R EPUTATIONAL C ONCERNS I NCENTIVES TO E CONOMIZE ON C ONTRACTING C OSTS C ASE S TUDY : E B AY . COM S UMMARY T EACHING THE C HAPTER We do not lecture extensively on this chapter. We begin class with a short summary of the key points in the chapter: the firm as a focal point of contracts, incentive conflicts in firms, the incentives to reduce agency costs and increase value, pre and postcontractual information problems, and repeated interaction and reputational concerns.
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Managerial Economics and Organizational Architecture Instructor’s Manual Part 1: Chapter Overview and Solutions Chapter 10: Page 2 An interesting example to illustrate some basic principles is the “story of the Chinese junks” (attributed to S. Cheung). In this example, there is a refined British lady who is taking a boat ride in China. A mean-looking man is yelling at the rowers and whips them when they fail to work hard. The lady comments to her guide that the British would not allow this cruel treatment of workers. Indeed, the owner of the boat would be put in jail for violating labor laws. The guide is amused by her statement and indicates that the people rowing the boat are the owners. The mean-looking man is an employee. We ask the students to explain what is going on. We want them to see that there is a free- rider problem among the owners (rowers). It is in the interests of the owners to solve this problem to increase the speed of the boat and to make higher profits. The hiring of the monitor is a solution to this collective-action problem. It is similar to having a police force in a society. The hardest concept in this chapter for the students to understand is the residual loss associated with agency problems. We clarify this concept opportunity cost by expanding on the voting game that we play with the students on the first day (see chapter 1).
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