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Coase Farm grows soybeans near property owned by Taggart Railroad. Taggart can build zero, one, or two railroad tracks adjacent to Coase Farm, yielding a net present value of \$0, \$9 million, or \$12 million.

_________________________________________________
Value of Taggart Railroad (in millions)
As a function of the Number of Train
Tracks (before any damages)

Zero tracks \$0
One track 9
Two tracks 12

Coase Farm can grow soybeans on zero, one or two fields, yielding a net present value of \$0, \$15 million, or \$18 million before any environmental damages inflicted by Taggart trains. Environmental damages inflicted by Taggart’s trains are \$4 million per track. Coase Farm’s payoffs as a function of the number of fields it uses to grow soybeans and the number of tracks that Taggart builds are shown below.

_________________________________________________
Value of Coase Farm (in millions)
as a Function of the Number
of Fields Planted and the Number of Train Tracks

Zero fields One field Two fields
Zero tracks \$0 \$15 \$18
One track 0 11 2 .

It is prohibitively expensive for Taggart Railroad and Coase Farm to enter into a long-tern contract regarding either party’s use of its land.

a. Suppose Taggart Railroad cannot be held liable for the damages its tracks inflict on Coase Farm. Show that taggart Railroad will build two tracks and Coase Farm will plant soybeans in one field.
b. Suppose Taggart Railroad can be held fully liable for the damages that its tracks inflict on Coase Farm. Show that Taggart Railroad will build one track and Coase will plant soybeans on two fields.
c. Now suppose Taggart Railroad and Coase Farm merge. Show that the merged firmwill build one track and plant soybeans in one field.
d. What are the implications of the merger for the organizational architecture of the newly merged firm in terms of decision rights, performance measurements, and employee compensation?

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