incentives & control. question what great document was written in 1776?
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Incentives & Control
Question
What great document was written in 1776?
Question
Why are some countries rich and some poor?
AnswerThe specialization of labor…
The Specialization of Labor Do one task, do it well Smith talked about movement away from self
sufficient farms to urban model of specialized craftsman
Later taken to the extreme in Scientific Management
M. Hammer (1996) “When I tell people what I do for a living, I tell them that I am reversing the Industrial Revolution”
Industrial Revolution
The widespread replacement of manual labor by machines that began in Britain in the 18th century and is still continuing in some parts of the world. The Industrial Revolution was the result of many fundamental, interrelated changes that transformed agricultural economies into industrial ones. The most immediate changes were in the nature of production. Goods that had traditionally been made in the home or in small workshops began to be manufactured in the factory. Productivity and technical efficiency grew dramatically, in part through the systematic application of scientific and practical knowledge to the manufacturing process. Efficiency was also enhanced when large groups of business enterprises were located within a limited area. The Industrial Revolution led to the growth of cities as people moved from rural areas into urban communities in search of work.
Taylor, F. (1929) The Principles of Scientific Management
Based on the idea that one can apply engineering principles to manage labor inputs in optimal fashion
Exemplified by Ford’s assembly line Work is disaggregated (each worker
performs a single motion). Work is simple, repetitive, routine, and highly structured; it requires low level of skill and judgment.
Tools: standards, statistics, mangers, formal reporting and coordination mechanisms
Taylorism
Develop a "science" for every job, including rules motion, standardized work implements, and proper working conditions.
Carefully select workers with the right abilities for the job.
Carefully train these workers to do the job, and give them proper incentives to cooperate with the job science.
Support these workers by planning their work and by smoothing the way as they go about their jobs.
Hawthorn Studies (Human Relations) organizations are social systems, not just technical economic systems we are motivated by many needs we are not always logical we are interdependent; our behavior is often shaped by the social context informal work group is a major factor in determining attitudes and
performance of individual workers management is only one factor affecting behavior; the informal group often
has a stronger impact job roles are more complex than job descriptions would suggest; people act
in many ways not covered by job descriptions there is no automatic correlation between individual and organizational
needs communication channels cover both logical/economic aspects of an
organization and feelings of people teamwork is essential for cooperation and sound technical decisions leadership should be modified to include concepts of human relations job satisfaction will lead to higher job productivity management requires effective social skills, not just technical skills
The Professional Manager
Berle, A.A. and G.C. Means (1932) The Modern Corporation and Private Property
Large companies are no longer run by the people that own them – isn’t this a problem???
Yes….Leads to Agency Conflicts
Potential Locations of Agency
Stockholders Board of Directors Senior management Middle managers Line employees Customers
CSS
CRM
SFA
Agency Sources
1. Potential divergence of interest2. Basis of gainful exchange or
transaction3. Difficulties in monitoring and
enforcing4. You do not bear the full consequences
of your actions
Solutions
Internal• Improve monitoring• Explicit incentive contracts. Linking pay to some operational
output – bonuses, options.• Achieving goal congruence – equity positions• Peer Approval• Signalling!!!!
External• Competing sources of information• Monitoring by markets (takeovers)• Sources of social governance eg. reputation, peer approval,
morals, religion, culture
Labor Markets
Primary: Internal labor markets, insulated from free market mechanisms of secondary markets. Incentives via opportunity of promotion.
Secondary: Skills paid at market rate, often hourly basis.
eLance economy? Are the boundaries between primary and secondary markets dissolving?
Promotions as Tournaments Require only ordinal information about who did better
rather than cardinal of absolute performance data Relative performance evaluation controls for the
exogenous factors that affect all individuals Bonus pool set in advance, employer has no reason
to misrepresent employee's performance to safe on performance bonus payments
Mitigates the need to bargain individually with employees over salary
Negative correlation between open position and salary differentials
Tenure & Partnership up or out low level jobs continuously turned over fresh ideas and outside perspectives close evaluation of outside candidates incentives to hold junior people down as
source of rents destroys incentives and ruins recruiting
Recent tendency of Big 3 extending equity positions down to lower levels… Why?
Property Rights
Why are some countries rich and some poor? D. North
"Economic growth will occur if property rights make it worthwhile to undertake socially productive activity".
Property rights should be clearly assigned, secure and transferable. (Pollution caused by the absence of well defined property rights – negative externality)
High complementarily + high specificity + uncertainty monitoring difficulty= integration
Equity & Partnershipcomplementary assets should be owned by the same
agent where complete contracts are impossible.
“People are our greatest resource”
Human knowledge can be bounded, socially embedded, tacit, context dependant, idiosyncratic, inalienable, sticky…
= complementary assets cannot be owned by single agent
Incentive Misalignment/Agency
Compensation Policy
Deal with uncertainties in earnings opportunities Signal what organization values and what
behavior and attitudes it wants to discourage Help employees decide how to allocate their time
and effort among competing ends Reward accomplishments/success and failures Provide motivation for behavior which contributes
to organizational success Meet employees needs for material consumption,
equity, status
Piece Rate
Some studies have indicated that productivity increases of 15-35% with implementation of piece rate.
Strong motivators Elicit self-selection Easily understood
Piece Rate Disadvantages
Variance in relationship between output and effort required
Exogenous, random variables can affect worker income
May contradict logic of assembly line production models
Encourages employees to ignore other valuable activities for company, unlikely to help or cooperate other employees
Group Incentives
Determining individual performance may be impossible
Groups have better information about contributions than employers
Groups are thus better monitors of one another Groups effective systems of internal behavioral
governance Groups encourage cooperation Group synergies to work in teams more
responsive to incentives
Decision Information Costs
Agency Costs
Centralized
DecentralizedLocal information
Bird’s eye coordination
Where combined costs (Int CC) are minimized
Where to place decision rights?
Agency Monitoring costsCosts Bonding costs
Internal Residual lossCoordination
Costs Decision Information processing costsInformation Communication
Costs Documentation
Opportunity costs due to poor information
Hierarchical Coordination
Internal Coordination Costs
Search costs Transportation costs
Operational Inventory holding costs External Communication costs
CoordinationCosts Costs of writing contracts
Costs of enforcing contractsContractual
Market Coordination
External Coordination Costs?
Transaction Costs
Internal Coordination & Operations Costs
Optimal Firm Size
Total Cost
Optimal Firm Size
Specific and General Knowledge
“It is with respect to this that practically every individual has some advantage over all others in that he possesses unique information of which beneficial use might be made only if the decisions depending on it are made with his active cooperation” (Hayek, 1945, p. 521-522)
There are two immediate options when attempting to co-locate knowledge and decision rights.
1. Moving the knowledge to those who make decisions2. Move the decision rights to those who have the
knowledgeConsequences1. A centralized system of control leads to high
information transferal costs and low agency costs2. A decentralized system leads to high agency costs
and lower information costs
The IS Problem
The IS Problem: Who cares???
Affects issues of: 1. Organization
2. Geographic location
3. Process definition and standardization
4. “Virtual” value chain coordination
Dependant upon:1. Uncertainty
2. Task definition
3. Interdependence
4. Risk
Old Economy or New Economy?
1. Data is visual, tactile and obtained directly from customers, suppliers and work
2. Workers tend to stay with firm because of pay schemes and benefits
3. Increasingly look outside of work for personal gratification and identity
4. Work is tightly integrated into family life and community
5. Emphasis on “tight control” of the production process through development of strict standards, policies and detailed procedures
Old Economy or New Economy?6. Increased isolation of workers from each
other and family and community7. Opportunities for career development are
limited except for as related to increased skill and expertise
8. Development of professional supervisor & middle manager roles; required to monitor work, control effort and output
9. Autonomous work teams are “empowered” to define work and manage production
Reengineering
Computers can gather most information more accurately and cost-effectively than people, they can produce summaries with electronic speeds, and they can transmit the information to decision-makers with the speed of light. Most interesting for our purposes is that, frequently, this information is so good and the analysis so precise that an executive decision is no longer required. . . . Anyone restructuring a company that does not take this new employee empowerment into account is not dealing with the future but is merely streamlining the past
Reengineering Principles Organize around outcomes, not tasks Have those that use the output of the process,
perform the process Subsume information-processing work into the
real work that produces the information Treat geographically dispersed resources as
though they were centralized Link parallel activities instead of integrating
their results Put the decision point where the work is
performed, and build control into the process Capture information once and at the source
Empowerment Define wide boundaries of procedural decision making Local sensitivity, responsiveness, Give employees authority to capitalize on here and
now..Problems Not always appropriate (risk, interdependence) Moral hazardSolutions Codify all alternatives in IT system, thus preempting
uncertainty (dangerous) Alternative, local governance mechanisms: e.g. teams
Across the hierarchy
ALKA Old sales process
contactcustomer
salesmeeting
sales leadlist
NO
Customer
Alka Regional office(Sales person)
Alka HQ
(Admin. processor)
sell policiy
registerinformation
Controlinformation
InformationOK?
YES
Specialistrequired?
specialist
YES
contactcustomer
contactsalesperson
confirminformation
confirminformation
NO
NO
NO
registercustomer
register/send policy
Policy
ALKA New sales process
contact customer
acceptcall
Customer
Alka HQ
register information
input cust. data in system
Specialist required?
specialist
send policy
Policy
NO
YES
Sales process reduced from 60 to 29 possible steps
ALKA Old claims adjustment
recordinformation
contactAlka
send claimsform
claims form written denial
controlinformation
requestadditional
information
coverage?
returnclaims form
input casedata in system
Info.OK?
exam byadjustor/specialist
payment
requestspecialist
requestadjustor
payment/close case
archive
evaluatecase
evaluatecase
NO
YES
NO
Customer
Alka Claims Admin.
Alka HQ
ALKA New claims adjustment
recordinformation
contactAlka
verbal denial(telehone)
coverage?input casedata in system
Info.OK?
exam byadjustor/specialist
payment
requestspecialist
requestadjustor
payment/close case
archive
evaluatecase
evaluatecase
YES
NO
Customer
Alka Claims Admin.
Alka HQ
Claims administration reduced from 139 to 44 possible stepsPaper based claims administration reduced from 97% to 4.8%Average accident claim processing time reduced from 32 to 6 days
Teams: Cooperation & Rivalry
Knowledge sharing & tournaments•Acquisition & coordination of knowledge•Reduction of asymmetric information•Increase learning
COOPERATION
COOPERATION
COOPERATIONCOOPERATION
COOPERATION
RIVALRY
Implicit Compensation
is often required when no explicit variables are readily available or easily measured. This is often the case with higher managerial positions, where the management of uncertainty is often required.
Empowerment can be seen as a move from an explicit to implicit incentive scheme.
Remember…Corporate Culture: Workable principles or routines of shared expectations that guide behavior in the face of uncertainty
Debate
Let it herewith be resolved, that this class believes that Taylorism/Bureaucratic-Hierarchy is dead.
The economy is returning to a work & employment model highly characterized by the Craft/Owner-operated economy.