Managerial Economics: Today’s Agenda

1. Managerial Economics: Today’s Agenda • Organizational Architecture • Kodak Case, P. 298 • Ethics and Organizational Architecture • Recycling Corporate Responsibility, WSJ • Giving Until it Hurts, WSJ • Nordstrom

2. The fundamental problem within firmsKnowledge and Incentives • Profit maximization may face information limitations • controlled by many individuals • may be costly to transfer • Individuals may have incompatible incentives • Organizational architecture must overcome these limitations

3. Basic Tenets of Economic Approach to Organizations • Self interest • Of employees, managers, even CEOs • Present to some extent • Architecture influences behavior • Behavior shaped by incentives • Implications for increasing value • Balance the 3-legged stool • Decision makers need specific knowledge to make appropriate decisions and the incentives to use the information productively

4. Components of architecture“three legs of the stool” • Decision-right assignment • empowering employees • who makes what decisions in organization • What knowledge/information does the decision maker have access to? • Reward system • compensating employees • Pecuniary; non-pecuniary • sets incentives • Performance-evaluation system • evaluating employees • accountability

5. Determinants of OrganizationalArchitectureGoals:· link decision rights with knowledge· motive agents to make productive decisions based on their information. · Reward value-enhancing decisions

6. Corporate culture • Culture is the set of explicit and implicit expectations of behavior within the firm • Culture includes formal organizational architecture • Communicating culture • slogans, rituals, role models

7. Case Analysis Questions • Does the strategy fit the business environment and capabilities of the firm? • What are key features of the current architecture? • Does the current architecture fit the business environment and strategy? Does it link specific knowledge & decision rights and provide incentives to use info productively? • Are 3 legs of stool mutually consistent? • If problems, what changes in strategy & architecture should firm consider? • What problems in implementing changes?

8. When architecture fails • Management is at risk of dismissal • Firm is at risk of takeover • Rivals are lurking in the wings • Can you say Enron???

9. Changing architecture • Benefits of organizational change must exceed costs • Costs • direct: resources for design and communication • indirect: short-timer effect on human capital development • Organizations are interdependent systems, change must be coordinated

10. Managerial implications • Consultant advice should be examined closely • e.g., employee empowerment may not always be appropriate • Effective benchmarking requires architectural awareness

11. Discussion Question • What is a major difference between the organizational architectures of markets and firms?

12. Evaluate this organizational architecture • Decision rights – pricing decision rights are assigned to the sales associate • Evaluation – the metric is sales volume per quarter • Compensation – flat salary plus commission tied to sales volume

13. Eastman Kodak, p. 298 • What factors motivated Kodak to change its organizational architecture? • What mistakes did Kodak make in changing its architecture? • What might it have done differently? • How does this relate to the concept of economic Darwinism?

14. Ethics and organizational architectureChapter 22 What is the Social Responsibility of Corporate Management? Karen Kozlowski (second from left) with friend and two models dressed as Roman centurions Before Indictment Dennis and Karen Kozlowski with two models dressed as Roman centurions

15. Ethical Conflicts • Individuals versus Legal Fictions • Principles and Agents • Patients and doctors • Client and attorney • God and people • Shareholders versus Stakeholders • What is a stakeholder? • Customers, employees, owners, suppliers, competitors, communities? • Caux Round Table • Animals, managers, trees, non-sentient things • Business Ethics literature

16. Friedman on Social Responsibility of Managers • “…there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud”. • Milton Friedman

17. “Corporate Social Responsibility” “The solution lies in business practices that reflect and respect the competing claims for all stakeholder groups. No longer simply a matter of publicity or philanthropy, socially responsible business practices affect all aspects of business operations and contribute significantly to corporate productivity and profitability.” -Website of Business for Social Responsibility: www.bsr.org

18. How do we get ethical behavior? • Altering preferences?  • Altering incentives!  • Distinguish between policies designed to alter preferences and those designed to alterincentives

19. Recycling Corporate Responsibility, WSJ • What is the author’s opinion about the opportunity costs of the stakeholder approach? • What is the author’s opinion about Enron? Arthur Anderson • What is the author’s prescription?

20. Giving Until it Hurts, WSJ • What was Berkshire Hathaway’s policy on corporate giving? • What were the key differences between A and B shares? • Was Berkshire Hathaway ethical? Was Warren Buffett ethical? • What problem identified in this editorial lead to a change in the policy? • Identify company’s solution and add recommendations of your own if you have any. It would be unusual NOT to have differences of opinion in your group in regard to these issues. You may wish to acknowledge these differences with a list of several alternative solutions. • Should corporations ever give to charity? Always give to charity? • Who should control decision rights concerning corporate philanthropy?

21. Discussion: Nordstrom • What is the causes of the problems described in this case? Is the three-legged stool balanced? • Are Nordstrom employees pressured inappropriately by the sales-per-hour system? By management? • How effective is the memo (Exhibit 3) in clarifying the distinction between “sell’ and “non-sell” time? • How would you change management systems at Nordstrom? • Would proposed changes in overtime eligibility benefit Nordstrom? Your firm? Workers?

22. Ethics Summary • The term ethics has many different meanings which can change across cultures and time. • If a corporation is to survive in a competitive environment, it must maximize value. Taking care of corporate “stakeholders,” such as employees and local communities can be important, but such care can only be taken so far. • Private markets provide strong incentives for ethical behavior by imposing substantial costs on institutions and individuals that depart form accepted social standards. • Some corporations misplace considerable effort in trying to change employees’ preferences through corporate ethics programs. The economic view, instead, takes the employees’ preferences as given and focuses on incentives.

23. Looking Forward • November 11 -8:00pm OEC Auditorium • “Tax Policy and the Economy” • Professor Joel Slemrod, University of Michigan • Optional for Monday and Tuesday Sections • November 15 and 16 • Managerial Economics Chapters 12 and 13 • Decision Rights • Medford University, p. 325 • Assignment 4: Due November 11, 15, and 16

24. Additional Ethics References • “The Social Responsibility of Corporate Management: A Classical Critique” by Coelho, McClure, and Spry (Friedman paradigm) • “A Response to The Social Responsibility of Corporate Management: A Classical Critique” by Post (Corporate Social Responsibility paradigm) • Mid-American Journal of Business, Vol. 18, No. 1 2003 at the following website: • http://www.bsu.edu/web/majb/