Lecture 1: The organisation of firms Flashcards
Name 2 theories for why firms exist:
Ronald Coase’s Theory
Oliver Hart’s Ownership Theory
What is the Ronald Coase theory?
The idea that firms exist as an alternative to the marketplace for organising production and can sometimes organise production more cheaply than the market.
Firms will expand until their internal transaction costs match those of the market.
what are the 2 extremes that Coase higlighted?
1) production carried out by individuals through market transactions - every step of production is done by a different person/business
This has high transaction costs and would be inefficient coordination of production
2) All production in a single huge firm
- loss of competition results in inefficiency
What is Oliver Harts ownership theory?
A firm is defined by its ownership of assets
the owner has stronger bargaining power in contract disputes
A person who owns an asset should be the one with the most incentive to improve its value
What are the advantages of Internal Transactions? (intergration)
Savings in transaction costs
More certainty when specialised equipment/skills are needed
What are the advantages of External Transactions (Market)?
Achieve economies of scale
Maintain smooth production flow
Utilise competition pressure
What does profit maximising require the aligning of?
Profit maximisation within a firm requires the aligning of the objectives of:
Workers
Managers
Firm Owners
How can workers be incentivised to stay in the firm?
Seniority based wage system - reward loyalty
Non wage compensation - bonuses, stock options
Efficiency wages - paying above the market wage to increase productivity and turnover
What is the Principal-Agent theory?
The principal (owner) hires and agent (manager) to maximise profits.
The manager however may not always act within their owners goals such as on the job perks.
What are 2 solutions to align objectives?
Internal control Mechanisms
External control Mechanisms
Name examples of Internal control Mechanisms
Corporate governance schemes - Define responsibilities
Monitoring - board of directors oversight
Proxy fights - the shareholders can vote on decisions and fire managers
performance based pay - align compensation with profit outcomes
must balance incentives and insurance
What are some external control mechanisms?
Threat of takeover bids
Competition in product markets
pressure from capital suppliers (investors)
