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Structure of Organizations for Production of Public and Private Goods

Structure of Organizations for Production of Public and Private Goods. Shyam Sunder, Yale University American Accounting Association’s International Visiting Lecturer Bogazici University, Istambul October 9, 2000. Compare Public and Private Good Organizations.

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Structure of Organizations for Production of Public and Private Goods

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  1. Structure of Organizations for Production of Public and Private Goods Shyam Sunder, Yale University American Accounting Association’s International Visiting Lecturer Bogazici University, Istambul October 9, 2000

  2. Compare Public and Private Good Organizations • Private good organizations produce and sell goods for a price to customers • Customers can impose discipline on them • Shareholders control manager by offering them net income based compensation

  3. Public Good Organizations • Public good organizations have beneficieries, not customers • Weaker or no customer discipline • Efficient production of public goods is very difficult • Solution is bureaucracy

  4. Outline • Organizations as a set of contracts • Accounting as a contract implemetation mechanism • Compare resource flows, management structure, decisions, and accounting in organizations • Examples and implications

  5. Subject Area Auditing Financial Manageral/Cost MAS/Systems Taxation Government Research All current Teaching (In percent) 11 44 21 5 10 1 3 Faculty Teaching by Subject

  6. Calls for Reforms • Arthur Andersen: Sound Financial Reporting in Public Sector: A Prerequisite to Fiscal Responsibility • Coopers & Lybrand: Financial Reporting Practices of American Cities: A Public Report • Touche Ross: Public Financial Reporting by Local Governments • Robert N. Anthony: Tell It Like It is

  7. Four Characteristics of Bureaucracy • Fixed wage • Impersonal rules • Tenure in job • Promotion from inside

  8. Cries in the Wilderness • Bolton: Don’t Put Government Financial Accounting in a Strait Jacket • Drebin: Is Accounting that is Good for General Motors Good for Detroit? • Mautz: Should Government Emulate Business?

  9. Legitimate Reasons for Different Accounting • Imposing business practices can cause considerable harm • Bureaucracy is an efficient solution to a difficult problem • Efficient production of public goods is a lot more difficult • Example: Besselman, Arora and Larkey Study of Defense Department

  10. Lack of Theory of Organizations to Produce Public Goods • Management curricula linked to economics. • Absence of economic theory of public good organizations • Economics and management courses emphasize private goods only. • Contract theory of organizations can help • An example of a lack of theory driving out teaching and practice

  11. A Framework for Contract Theory of Organizations • Chester Barnard, President, Bell Telephone Company of New Jersey • Functions of the Executive 1937 • Herbert A. Simon, Administrative Behavior, 1946

  12. Necessary Conditions • 1) Individual Condition: Each participants expects to receive at least the opportunity cost of contributions he/she makes to the organization • 2) Aggregate Condition: Contributions of all participants can produce enough output to meet the expectations of all

  13. Functions of Accounting • Measures resource contributions • Determines inducements • Compares contributions to inducements

  14. Special Problems in Control of Managers • At the procedural hub of the contracts • Control resources, have information • Monitor and negotiate with others • Difficult to measure their contributions • Can appropriate resources and information • Misappropriation difficult to detect • Devising a scheme to induce managers to contribute what is expected of her

  15. What are public and private goods? • Pure public goods satisfy two conditions: • Zero marginal cost of serving an additional user • Nonexcludability: those who do not pay still benefit. • Examples: National defense for citizens of U.S. Public radio in city

  16. Pure private goods do not satisfy either condition • Examples: a cup of coffee, car, suit • Most goods and services lie in between the two extremes of pure public and pure private goods

  17. Comparing Private and Public Good Organizations • Resource flows • Residual Claims • Product Market Discipline • Decision Making • Product • Investment • Accounting and Control

  18. Resource Flows • Unreciprocated outflow to beneficiaries • No quid pro quo • Need unreciprocated inflow (tax, gifts) • Captial versus revenue account cash flows • In Public good organizations, capital flows are “revenue” contributions

  19. Residual Claims • An economizing device in private good organizations • Reduce the number of contracting relationships • Residual claimant given control (susceptible to others' non-performance) • All agents can protect their interests directly

  20. Stock Market Consequences of Residual Claims • Trading in residual claims (stock market) • Creates incentives to gather and produce information • A large information industry exists • Capitalizability of residual claims induces interest in longer term resource flows

  21. Public Goods Organizations • No tradeable residual claims • Weaker incentives to search for information • Weaker concern for the longer run (e.g., Social Security debates)

  22. Defining Managers’ Contracts • Private Good Organizations make it self-enforcing: link compensation to the residual (accounting and audit) • No product market discipline  No link of managerial compensation to residual

  23. Product Market Discipline • Customers in PGOs negotiate terms • No transaction if not satisfied • Can withhold revenues • Residual-based contract for managers possible

  24. Public Good Organizations’ Beneficiaries • Cannot withhold resources directly • Would continue to consume resources of poorer quality

  25. Private Good Contract in Public Good Organization • Dysfunctional • Simple for managers to maximize the residual by cutting the quality or quantity • This makes the organization becomes redundant • Efficient structure for private goods is not efficient for public goods

  26. Redistribution of Decision Rights • This Problem in public good organizations is addressed by Redistribution of decision making responsibilities • Managerial contract delinked from residual

  27. Product Decision Rights • Managers have information, expertise, and decision rights in private good • In public goods, the governing body specifies what is produced, quantity, quality, and who gets them, because it pays for them • Residual generation is irrelevant because the net residual is negative

  28. Product Decision Rights in Public Good Organizations • The informational advantage managers in private goods is left unused in public goods • Managers not offered incentives to look for newer types of public goods • They may do so to seek promotion and power, retain jobs

  29. Investment/Production Decision Rights • Managers choose residual maximizing quantity, quality using their information • Delegation of quantity decisions possible through linkage between residual and remuneration • Investment decisions are derived decisions from the quantity decisions

  30. Investment/Production Decision Rights in Public Goods Orgs. • In public goods, governing bodies make quantity and quality decisions, • And therefore, the capital investment decisions

  31. Accounting and Controls • Differences between internal control and financial reporting • Differences often misinterpreted as prima facie evidence of poorly designed or poorly run public-good organizations

  32. Accounting and Control Differences • Entities • Funds • Consolidation • Assets/Depreciation • Revenue (cash versus accrual) • Budgets

  33. Entities, Funds and Consolidation • Restrictions on use of funds to make each fund a separate entity • Governing bodies direct funds to implement their production decisions • Beneficiaries cannot discipline the managers • Segregation of funds is a device to implement the contract

  34. Detail in Public Good Financial Reports • Even small public good organizaations have fat financial reports • Why do they not aggregate?

  35. Reports Reflect the Decision Structure • Governing boards make product/investment decisions • Public good org. reports comparable to middle management reports • Each fund serves a different constituency • If funds cannot be commingled, why consolidate?

  36. Fixed Assets and Depreciation • Private‑good: Record and value of long‑term assets at acquisition cost • Expense as cost of production over life • Use of standard formulas • Statistical inaccuracy vs. objectivity • Valuation of individual assets and the residual rights for transactions • Useful for traders

  37. Public Good Organizations • Residual rights not traded • Sale of fixed assets infrequent • Uniqueness of many assets (Mount Rushmore) • Dominant market position • Nonmonetary disclosure of assets • Not sure if some assets are liabilities

  38. Depreciation in Private Good Organizations • Three functions: • Estimating the residual surplus • Information value of residual surplus • Important statistic for all (viability, renegotiation) • Charging depreciation to the cost of production for pricing decisions • Induce managers to goal congruence

  39. In Public Good Organizations • none of the above three reasons applicable • No residual claimant • Public goods are not sold • Production investment decisions made by governing bodies

  40. Accruals and Revenue/Expense Recognition • In Private good organizations, realization principle represents the quid pro quo with the customers • No quid pro quo for transactions in public-good organizations • In absence of quid pro quo, applying accrual principle is chasing form, not substance

  41. Budgets, Appropriations and Encumbrances • Governing bodies of public-good organizations appropriate funds for specific items • The budget is an authorization to spend

  42. Which one is the Independent Variable? • Legal charter • Interal Revenue Service Rules on tax status • Economic characteristics of organization’s output

  43. Considered Polar Cases Only • Pure public and pure private goods are two polar cases • Most goods, and organizations that produce them lie in between • Rich spectrum of opportunities for study of organizations, economics and accounting controls

  44. Bureaucracy As A Dirty Word • Bureaucracy is the oldest form of management • Does not receive a fair shake in press • Perhaps overused in welfare state • But it is necessary for many functions • Lack of understanding leads to misguided attempts at reform that can backfire

  45. Unequal Race • Efficient production of public goods is more difficult than private goods (lack of customer discipline on managers) • Always room for improvement in current practices

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