Lecture 6 - Internal Organization

Question 1

Definition: Decision rights

Answer 1

Property rights inside firms.
These are delegated to hierarchical inferiors.

Question 2

Delegation & Decision quality

Answer 2

Centralized firms will be good at rejecting projects – but will also reject more good projects.
Decentralized firms will be good at accepting projects – but will also accept more bad projects.

When to use what:
- Decentralization: When you must avoid the error of rejecting good projects
- Firms in industries with hefty competition and a strong emphasis on innovation
- Centralization: When you must avoid the error of accepting bad projects.
- Medical approval authorities

Question 3

What is delegated

Answer 3

Actions that relate to projects and to which decision rights may be defined

Question 4

How to delegate

Answer 4

Making optimal use of such knowledge requires that it is matched with those who can make best use of it, and they are allowed to act on it. I.e., a collocation of knowledge and decision right. Which leads to delegation.

Colocation
allowing those with the knowledge to act on the knowledge.

Key tole of top-management is to choose delegation / allocation of decision rights so that efficient colocation takes place and value is maximized.

Process of delegation: design/calibrate
- Job descriptions
- Budgets
- Rules / internal common laws

Question 5

Benefits of delegation

Answer 5

• Cost of time:
  Managers are busy.
  The cost of an inferior employee is less than a manager (because the salary is lower).
• Speedy decision-making:
  Some decisions cannot wait until we have talked to 1-3 hieratical superiors who will then think about what should be done and then communicate that to us.
• Motivation:
  Employees want to be empowered
  Signal of trust in employees
  Prove yourself
  And thereby potentially boost future income stream
• Utilizing local tacit knowledge:
  Much knowledge is local and tacit, which cannot be centralized, or only at high cost.
  Specific knowledge (local & tacit) is primarily important to business decision making. So, it’s important to exploit it the right way.

Question 6

Costs of delegation

Answer 6

• Agency costs
  o Cost centers
  o Profit centers
  o Other solutions (e.g., job descriptions)
• (Evaluation mistakes)
• (Costs of coordinating interdependent activities in the face of change)

Question 7

Optimum delegation

Answer 7

When we have marginal benefits and marginal costs, we can draw curves.
The total organizational costs sum the two cost curves.

Question 8

Improved measures / monitoring effect on optimum delegation

Answer 8

Improved measures –>
possible to introduce performance based pay –>
higher beta –>
solves agency problem –>
lower agency cost curve –>
increase delegation –>
could also increase costs of poor information

Question 9

Problems in the spaghetti organization (additional costs of delegation) / coordination & cooperation problems

Answer 9

• High importance of relationships to top-management
• Performance pay hurt knowledge sharing
• No incentive measurement on knowledge sharing
• Time-allocation wasn’t registered
• Much management intervention –> decreased motivation

Question 10

Delegation & Intervention

Answer 10

Managers may delegate rights, but often intervene/overrule –> decrease motivation
Outsourcing avoids this problem