Piece-rates and time-rates in the firm

1. Payment Schedules, Moral Hazard and Effort Although employment contracts were discussed at various points in Chapter 5, it will be useful to reinterpret some of the principal-agent results in terms of more conventional concepts. Our analysis thus far has been conducted with the aid of a simple box diagram, with each point in

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Contracts and adverse selection in the firm

1.  MONITORING AND MORAL HAZARD Monitoring is a response to the problem of ‘moral hazard’. Because people, by assumption, cannot be relied upon to keep a promise to exert effort e, ‘direct incentives’ via piece-rates are required to ensure compli­ance. The risk-sharing losses involved are the result of moral hazard, but they may be

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Problem of moral hazard in the firm

1. MONITORING AND ADVERSE SELECTION Monitoring may also be required to cope with a quite separate problem; that of ‘adverse selection’. A simple model of adverse selection has already been considered in section 2.2. Here the analysis is extended to incorporate risk aversion, while the contractors are assumed to vary in the cost of

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The rank-order tournament in the firm

1. Incentives and the Structure of a Tournament This suggestion that a proportion of the workforce be offered a ‘prize’ (pro­motion) is an application of the incentive structure underlying the rank­order tournament. In a tournament, compensation is based not on the absolute level of individual output, but simply on the rank order of con­testants.

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Idiosyncratic exchange, rent seeking, entrepreneurship and opportunism

1. IDIOSYNCRATIC EXCHANGE The analysis of sections 3 to 6 helps us to rationalise some of the charac­teristics of hierarchical structures. Even in the context of identical employ­ees performing identical tasks it is possible to understand the development of recognisable hierarchies. We have seen that the provision of effort incen­tives where individual output cannot

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The firm as a governance structure

1. The Internal Labour Market A description of the major ‘contracting modes’ (the spot contract, the state-contingent contract and the authority relation) has already been pre­sented at the end of Chapter 2, along with a brief outline of Williamson’s criticism of these modes. Bounded rationality and opportunistic behaviour deriving from task idiosyncrasy, he argues,

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The Japanese firm

The ideas introduced in this chapter have recently been widely discussed in the context of the contrast between hierarchical structures in Japan and those in the United States and other Western countries. We cannot offer a survey of what is now a very large literature.33 However, even a cursory sketch reveals how closely the

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The variety of business enterprise

The firm investigated in Chapter 6 was beginning to take on some of the characteristics of hierarchical organisations and to reflect a few of the structural features associated with modern business enterprise, but our dis­cussion of internal structure is hardly complete. We have presented various attempts at rationalising employment hierarchies, yet many other charac­teristics

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Strategy and structure of the firm

The degree of vertical, lateral, conglomerate or international integration reflects the firm’s strategic development. Another important feature of the firm is its internal administrative structure. In Chapter 6, we investigated the incentive properties of simple hierarchies, but we did not consider in what ways administrative systems might differ and whether any differences between firms

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Visible and invisible hands governing the firm

1. The Boundary of the Firm From sections 1 and 2 of this chapter we have seen that the ‘visible hand’ can guide the process of resource allocation and integrate vertical, lateral, conglomerate or international transactions using a variety of corporate structures. As has been remarked in earlier chapters, however, the distinc­tion between visible

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Integration, complexity and environmental uncertainty

After reviewing the literature on corporate strategy and structure, Caves (1980) remarks that much of it seems implicitly to be concerned with the concept of an ‘organisational production function’. The ‘inputs’ into this function, he argues, are resources devoted to collecting and analysing infor­mation and coordinating other factors of production. The ‘output’ is the

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Integration, internalisation and market failure

In this section, we consider integration in the context of market failure. The analysis runs parallel to that of Chapter 6 on the policing of labour con­tracts, but here the emphasis is on the problem of contracting with buyers or suppliers of non-labour inputs. Integration as a means of overcoming transactional hazards is sometimes

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Integration and innovation of the firm

The ideas of Goldberg and others on the role of long-term commitments in coping with specific capital investments in the context of technical change lead naturally to an appraisal of the firm as a device for initiating change. In subsection 4, our attention was focused on flexibility and adapt­ability in the face of an

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Corporate governance and managerial control of the firm

1. WHO CONTROLS THE JOINT-STOCK FIRM? The firm, according to the paradigm that we are exploring in this book, is a nexus of contracts. These contracts establish an allocation of property rights among the individuals who comprise the firm. They may include rights to monitor, to administer resources, to receive income flows, to hire

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Managerial incentive contracts in the firm

1. Managerial Incentives and the Theory of Principal and Agent When the provider of capital appoints a manager to decide how it should be used, an agency problem arises. In Chapter 5, it was seen that the nature of a contract between principal and agent will depend upon what can be observed, by whom,

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Monitoring managers in the firm

1. Do Shareholders Monitor Managers? The analysis of section 4 applied to the standard case in which the effort of the agent was ‘unobservable’. Could it be, however, that some monitoring of managers by shareholders is feasible? Let us envisage that managerial services are purchased from specialist suppliers. The nature of the service is

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The managerial labour market and product market

1. THE MANAGERIAL LABOUR MARKET There are two different strands of thought in the literature on the manage­rial labour market, which are central to our discussion here. There is first the idea of the labour market as complementary to the internal incentive and monitoring systems of the firm. A second distinct theme is the

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The takeover and capital structure of the firm

1. THE ENTREPRENEUR AND THE TAKEOVER Inherently, a joint-stock firm is neither concentrated nor dispersed in the structure of its shareholdings. No document or constitution exists pro­claiming that a particular company’s shares will be dispersed widely. The degree of concentration or dispersion is capable of changing over time. It may appear at any given

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Hostile takeovers and economic efficiency

1. DEFENCES AGAINST HOSTILE TAKEOVERS 1.1. Supermajority Amendments If shareholders believe that the risk of takeover could have adverse conse­quences for the value of the firm, they could make adjustments to their corporate constitutions. Changes in the composition of the Board of Directors or mergers would have to be approved by more than a

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Capital structure and corporate governance of the firm

1. The Modigliani-Miller Theorem Throughout this chapter the agency problems of corporate control have been to the fore. Yet, although financial instruments such as ordinary shares and various types of debt have been mentioned and the conse­quences for incentives have been noted, we have not linked observed finan­cial structure systematically to control problems. The

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