13orgn_sg - Chapter 13 Incentives and Organization Chapter...

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Chapter 13: Incentives and Organization Chapter 13 Incentives and Organizations CHAPTER SUMMARY The architecture of an organization comprises the distribution of ownership, incentive schemes, and monitoring systems. Ownership means the rights to residual control. Incentive schemes and monitoring systems are related as incentives must be based on behavior that can be observed. An efficient incentive scheme balances the incentive for effort with the cost of risk. An efficient organizational architecture resolves four internal issues – holdup, moral hazard, monopoly power, and economies of scale. Holdup and moral hazard arise between parties with a conflict of interest. Additionally, moral hazard depends on one party not being able to observe the actions of the other. Holdup can also be resolved through more detailed contracts, moral hazard through incentive schemes and monitoring systems, and internal monopoly power through out-sourcing. KEY CONCEPTS organizational architecture relative performance ownership m o r a l h a z a r d h o l d u p r e s i d u a l c o
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Chapter 13: Incentives and Organization NOTES 1. Organizational architecture . (a) Organizational architecture comprises incentive schemes, monitoring systems, and the distribution of ownership. The vertical and horizontal boundaries of the organization are two implications of the organizational architecture. (b) An efficient organizational architecture revolves and should be designed to balance 4 internal issues: moral hazard, holdup, monopoly power, and economies of scale and scope. 2. Moral hazard . (a) Moral hazard exists when one party’s actions affect but are not observed by another party with whom it has a conflict of interest, e.g., delivery persons, sales representatives are subject to moral hazards. (b) Moral hazard arises only when there is asymmetric information about the future actions of the better-informed party. (c) Economic efficiency . The relevant parties would like to resolve the moral hazard so that the better-informed party will make the economically efficient choice. i. The degree of moral hazard is measured by the discrepancy between the actual action or effort and the economically efficient level. ii.
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This note was uploaded on 12/21/2011 for the course ECON 3014 taught by Professor Michaelshaw during the Spring '11 term at HKU.

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13orgn_sg - Chapter 13 Incentives and Organization Chapter...

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