Jensen & Meckling
* As played by George Clooney
Specific and General Knowledge, and
Organizational Structure
“…we analyze the institutional devices through which decision
making rights are assigned in markets and within firms and the
devices used to motivate agents to make proper decisions.” (p. 1)
Goals:
1. What is the difference between general and specific knowledge?
2. What difference does it make for organizational structure?
How do markets & firms “solve the rights assignment and
control problems”?
“Alienability solves the control rights
problem” (p. 12)
Those with the knowledge buy the
decision rights; or those with the
decision rights buy the knowledge (p. 5)
Who should have the rights &
Rewards and punishments (p. 13)
“Firms must obtain advantage from the
suppression of alienability… (p. 14)
Knowledge considerations are one
cause of the emergence of firms.”
“The assignment and enforcement of
decision rights in organizations are a
matter or organizational policy and
practice, not voluntary exchange.”
What document is this quote from?
“A right is alienable if its owner has the right
to sell a right and capture the proceeds
offered in the exchange.” p.2 (see also p. 12)
“…the CEO in the typical firm cannot generally use alienability to
solve the firm’s organizational problems…Organizational problems
within the firm must therefore be solved…by devising a set of rules
of the game for the firm which:
1. Partition out the decision making rights to agents throughout the
organization.
2. Create a control system that
a) provides measures of performance;
b) specifies the relationship between rewards and punishments
and the measures of performance.
…knowledge of these rules of the game enables one to make good
predictions about an organization’s behavior and effectiveness.” p.21
What do J&M mean by “control”?
“Control is the process and rules
governing the measures of
performance, and the rewards and
punishments meted out in response
to individual actions” (p. 12)
How does the
MARKET
“control”?
“Minimizing cost for given total output often seems to degrade into a
system where managers are rewarded for minimizing average cost per unit
of output…measuring performance by average cost per unit of output will
virtually never be consistent with firm value maximization in the absence
of a quantity constraint” p. 25.
General Knowledge
Specific Knowledge
Costly to transfer!
“Specific knowledge… is often acquired jointly
with the production of other goods.” (p. 6)
“Effective transfer” of knowledge:
“The recipient of knowledge is presumed to understand the
message well enough to act on it.”
Because time is often important in taking advantage of opportunities for
arbitrage or for exploiting knowledge of unemployed resources,
delays in actions are costly.” (p. 7)
True story: when Professor Kohn was in 4th grade she tried to
run away and join the circus to be a juggling clown riding a
unicycle.
“The limitations on human mental and sensory faculties mean that storing,
processing, transmitting and receiving knowledge are costly activities.” (p.
4)
Herbert Simon
Models of Bounded Rationality (1982)
http://en.wikipedia.org/wiki/Herbert_Simon
Shari Gifford
“Limited Attention as the Bound on Rationality”
(2005)
“The limitations of (the CEO’s) own mental and communication abilities make
it impossible for the CEO to gather the requisite information to make every
detailed decision personally…delegating authority…requires consideration of
the costs of generating and transferring knowledge…” (p. 17)
Optimal Allocation of Decision Rights
“The key to efficiency is to assign decision rights to each agent at each level to
minimize the sum of the costs owing to poor information and the costs owing to
inconsistent objectives” p. 19
Agency costs =
designing
+ implementing
+ maintaining system
+ residual loss from bad decisions
?
The more specific the knowledge needed to
make a decision the more you should allocate
the decision right to the person with the
knowledge rather than incur the cost of
transferring the knowledge to someone else
with the decision right.
“Changes in information technology have an ambiguous impact on
the optimal degree of decentralization…When improved
technology makes it easier to transfer specific knowledge
effectively from lower to higher levels…there will be a shift
toward centralization. When improved technology makes it easier
to transfer to lower levels in the organization information that
formerly was specific to higher levels…there will be a shift toward
decentralization.” (p. 20)
“Increased government regulation tends to increase centralization
…by increasing the amount of specific knowledge in the
headquarters office dealing with the regulatory agency.” (p. 20)
“Where the production, transfer, and application of knowledge are the
primary goods being offered, however, exchanges tend to take the form of
long-term relationships, and the most common of these is employment
contracts…The transaction costs emphasized by Coase (1937) and
Williamson (1975) are one reason such contracts emerge. Single
proprietors who contract on a case-by-case basis for production and
application of all knowledge would soon find themselves swamped by
transaction costs in all but the smallest scale firms.” p. 15
“Particularly challenging information transfer problems arise in
situations where optimal decision-making requires integration of
specific knowledge located in widely separate individuals.
Integrating the specific knowledge of marketing, manufacturing,
and R&D personnel to design and bring a new product to the
market is an example” p. 8.
: “…optimal architectures will differ across companies. Such
structural differences are not random but vary in systematic ways
with differences in certain underlying characteristics of the
companies themselves.” BSZ p. 345
Decision Rights
Characteristic #1:
Type of Information
General & Specific Knowledge
Cost of bad decisions!
Characteristic #2
Speed of Decisions
Marginal cost of poor
incentives = marginal
cost of bad decisions
Speed increases the cost
of knowledge transfer
Incentives
Monitoring &
Evaluation
Greater decision rights
require greater
incentives
Greater incentives
require measuring
outcomes
Greater decision rights
require greater
incentives
Greater incentives
require measuring
outcomes
Characteristic #3
Observability of
outcomes
Outcomes cannot easily
be traced back to specific
decisions by individuals
Risk and risk aversion
can dilute incentives
Inability to measure
Precludes incentives
“The tendency for large organizations to avoid pay-for-performance incentive
plans and to rely instead on promotion-based rewards is an interesting
phenomenon that is as yet poorly understood by economists.” (p. 28)
Incentive Pay (see Ch. 15 in text)
Key problem: if you can’t observe effort agents can easily blame
poor performance on bad luck (see p. 460 in text)
Fixed wages
Commissions
1. Observability of output
2. Risk aversion of agents
3. Forces beyond agents’ control
Tradeoffs
Specific
Knowledge
Monitoring
Transactions
Costs
Information
Asymmetry
Decision
Rights
Incentives
Trust