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Unformatted text preview: CHAPTER 6 Reasons for Firm Incentives Amazing things happen when people take responsibility for everything themselves. The results are quite different, and at times people are unrecognizable. Work changes and attitudes to it, too. Mikhail Gorbachev n conventional economic discussions of how firms are managed, incentives are nowhere considered. This is the case because the firm is little more than a theoretical black box in which things happen somewhat mysteriously. Economists typically acknowledge that the firm is the basic production unit, but little or nothing is said of why the firm ever came into existence or, for that matter, what the firm is. As a consequence, we are told little about why firms do what they do (and dont do). There is nothing in conventional discussions that tells us about the role of real people in a firm. How are firms to be distinguished from the markets they inhabit, especially in terms of the incentives people in firms and markets face? That question is seldom addressed (other than, perhaps, specifying that firms can be one of several legal forms, for example, proprietorships, partnerships, professional associations, or corporations). In conventional discussions of the theory of the firm, firms maximize their profits, which is their only noted raison dtre . But students of conventional theory are never told how firms do what they are supposed to do, or why they do what they do. The owners, presumably, devise ways to ensure that everyone in the organization follows instructions, all of which are intent on squeezing every ounce of profit from every opportunity. Students are never told what the instructions are or what is done to ensure that workers follow them. The structure of incentives inside the firm never comes up because their purpose is effectively assumed away: people do what they are supposed to do, naturally or by some unspecified mysterious process. For people in business, the economists approach to the firm must appear strange indeed, given that business people spend much of their working day trying to coax people to do what they are supposed to do. Nothing is less automatic in business than getting people to pay attention to their firms profits (as distinguished from the workers more personal concerns). In this chapter, before we delve into the structure of firm costs in following chapters, we address the issue of why firms exist not because it is an interesting philosophical question. Rather, we are concerned with that question because its answer can help us understand why the existence of firms and incentives go hand in hand. There is more than an ounce of truth to the refrain, You cannot have one without the other. In this chapter, we lay out the limited I Chapter 6. Reasons for Firm Incentives 2 economic propositions that will undergird the analysis of much of the book. These propositions are powerful as they are simple, are relatively easily to understand. are powerful as they are simple, are relatively easily to understand....
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