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1. Who is making the bad decision?;2. Do they have enough information to make a good decision?; and3. Do they have the incentive to do so?
1. Let someone else make the decision – someone with better information or incentives;2. Give more information to the current decision-maker; or3. Change the current decision-maker’s incentives.Students use benefit-cost analysis to choose from among the viable solutions.Those of you familiar with the so-called Rochester approach to Organizational Design should recognize the similarity of this problem-solving algorithm to the “three legs” of Organizational Architecture – decision rights, performance evaluation, and reward structures – developed by Jensen and Meckling (2000) and later refined by Brickley, Smith, and Zimmerman (1997). It differs in that they decompose incentives into two pieces, performance evaluation and reward schemes, rather than lump them together, and don’t consider information flows separately from the incentives. The justification for this difference is that decision makers with appropriately designed per-formance evaluation metrics and reward schemes already have an incentive to gather the information necessary to make a good decision. The substance is similar, but it is often useful to consider the problem of information acquisition separately from incentives.EXAMPLESHigh Transportation Costs at a Coal-burning UtilityA power-generating utility owns a large coal-burning power plant on a river and each week a dozen barges arrive loaded with coal to feed the power plant. The transportation division of the parent company is responsible for transporting coal to the power plant, and it pays a barge company to pick up the coal at a railhead and transport it down river.Once a barge arrives at the docks, the power plant is very slow to unload the coal because they have just one crew of dockworkers and they rarely work overtime or on weekends. The barge company gives its customers three days to unload the coal, but if it takes longer, it charges late fees of $500 per day. Because very few barges are unloaded within three days, the transportation division pays very high late fees.The immediate problem is that the late fees paid by the transportation division are bigger than the overtime fees that would cause them to disappear, but the unloaded barges also represent inefficiency, in other words, the barges have a higher valued use in transporting coal to other customers.