Managerial Economics and Organizational Architecture, Seventh Edition
By James A. Brickley, Clifford W. Smith and Jerold L. Zimmerman
Contents
Part 1: Basic Concepts
Chapter 1: Introduction 1
Managerial Economics and Organizational Architecture 2
Organizational Architecture 3
Economic Analysis 4
Economic Darwinism 6
Survival of the Fittest 6
Economic Darwinism and Benchmarking 6
Purpose of the Book 8
Our Approach to Organizations 8
Chapter 2: Economists’ View of Behavior 12
Economic Behavior: An Overview 13
Economic Choice 13
Marginal Analysis 14
Opportunity Costs 16
Creativity of Individuals 16
Graphical Tools 18
Individual Objectives 18
Indifference Curves 19
Opportunities and Constraints 20
Individual Choice 23
Changes in Choice 24
Motivating Honesty at Wells Fargo 26
Managerial Implications 29
Alternative Models of Behavior 30
Only-Money-Matters Model 31
Happy-Is-Productive Model 31
Good-Citizen Model 32
Product-of-the-Environment Model 33
Which Model Should Managers Use? 33
Behavioral Economics 35
Decision Making under Uncertainty 36
Expected Value 36
Variability 36
Risk Aversion 37
Certainty Equivalent and Risk Premium 38
Risk Aversion and Compensation 38
Summary 39
Appendix A: Consumer Choice 46
Appendix B: Inter-Temporal Decisions and the Fisher Separation Theorem
59
Chapter 3: Exchange and Markets 64
Goals of Economic Systems 65
Property Rights and Exchange in a Market Economy 66
Dimensions of Property Rights 67
Gains from Trade 67
Basics of Supply and Demand 72
The Price Mechanism 73
Shifts in Curves versus Movements along Curves 76
Using Supply and Demand Analysis for Qualitative Forecasts 76
Linear Supply and Demand 77
Supply and Demand—Extended Analysis 79
Price versus Quantity Adjustments 79
Short-Run versus Long-Run Effects 81
Industry Cost Increases and Price Adjustments 83
Prices as Social Coordinators 87
Efficient Exchange and Production 87
Measuring the Gains from Trade 87
Government Intervention 88
Externalities and the Coase Theorem 93
Markets versus Central Planning 95
General versus Specific Knowledge 95
Knowledge Creation 96
Specific Knowledge and the Economic System 98
Incentives in Markets 99
Contracting Costs and Existence of Firms 100
Contracting Costs in Markets 100
Contracting Costs within Firms 102
Managerial Decisions 103
Summary 104
Appendix: Shareholder Value and Market Efficiency 112
Part 2: Managerial Economics
Chapter 4: Demand 117
Demand Functions 118
Demand Curves 119
Law of Demand 121
Elasticity of Demand 121
Linear Demand Curves 126
Other Factors That Influence Demand 128
Prices of Related Products 128
Income 130
Other Variables 132
Industry versus Firm Demand 133
Network Effects 134
Product Attributes 136
Product Life Cycles 137
Demand Estimation 138
Interviews 139
Price Experimentation 139
Statistical Analysis 140
Implications 143
Summary 144
Appendix: Demand 151
Chapter 5: Production and Cost 154
Production Functions 155
Returns to Scale 156
Returns to a Factor 157
Choice of Inputs 160
Production Isoquants 160
Isocost Lines 162
Cost Minimization 163
Changes in Input Prices 164
Costs 166
Cost Curves 166
Short Run versus Long Run 169
Minimum Efficient Scale 173
Economies and Diseconomies of Scale 174
Learning Curves 175
Economies of Scope 176
Profit Maximization 177
Factor Demand Curves 178
Cost Estimation 181
Summary 183
Appendix: The Factor-Balance Equation 189
Chapter 6: Market Structure 190
Markets 192
Competitive Markets 192
Firm Supply 192
Competitive Equilibrium 195
Barriers to Entry 198
Incumbent Reactions 199
Incumbent Advantages 200
Exit Costs 201
Monopoly 201
Monopolistic Competition 203
Oligopoly 205
Nash Equilibrium 206
Output Competition 207
Price Competition 209
Empirical Evidence 210
Cooperation and the Prisoners’ Dilemma 211
Summary 215
Chapter 7: Pricing with Market Power 221
Pricing Objective 222
Benchmark Case: Single Price per Unit 223
Profit Maximization 223
Estimating the Profit-Maximizing Price 226
Potential for Higher Profits 228
Homogeneous Consumer Demands 229
Block Pricing 229
Two-Part Tariffs 231
Price Discrimination—Heterogeneous Consumer Demands 232
Exploiting Information about Individual Demands 233
Using Information about the Distribution of Demands 236
Bundling 240
Other Concerns 242
Multiperiod Considerations 242
Strategic Interaction 243
Legal Issues 244
Implementing a Pricing Strategy 245
Summary 247
Chapter 8: Economics of Strategy: Creating and Capturing
Value 254
Strategy 255
Value Creation 256
Production and Producer Transaction Costs 258
Consumer Transaction Costs 258
Other Ways to Increase Demand 259
New Products and Services 262
Cooperating to Increase Value 262
Converting Organizational Knowledge into Value 263
Opportunities to Create Value 264
Capturing Value 266
Market Power 267
Superior Factors of Production 270
A Partial Explanation for Walmart’s Success 275
All Good Things Must End 277
Economics of Diversification 279
Benefits of Diversification 279
Costs of Diversification 280
Management Implications 281
Strategy Formulation 283
Understanding Resources and Capabilities 283
Understanding the Environment 284
Combining Environmental and Internal Analyses 284
Strategy and Organizational Architecture 285
Can All Firms Capture Value? 286
Summary 287
Chapter 9: Economics of Strategy: Game Theory 293
Game Theory 294
Simultaneous-Move, Nonrepeated Interaction 295
Analyzing the Payoffs 296
Dominant Strategies 296
Nash Equilibrium Revisited 298
Competition versus Coordination 300
Mixed Strategies 303
Managerial Implications 305
Sequential Interactions 307
First-Mover Advantage 309
Strategic Moves 309
Managerial Implications 310
Repeated Strategic Interaction 311
Strategic Interaction and Organizational Architecture 313
Summary 315
Appendix: Repeated Interaction and the Teammates’ Dilemma 320
Chapter 10: Incentive Conflicts and Contracts 326
Firms 328
Incentive Conflicts within Firms 329
Owner-Manager Conflicts 329
Other Conflicts 331
Controlling Incentive Problems through Contracts 332
Costless Contracting 333
Costly Contracting and Asymmetric Information 335
Postcontractual Information Problems 336
Precontractual Information Problems 340
Implicit Contracts and Reputational Concerns 343
Incentives to Economize on Contracting Costs 345
Summary 347
Part 3: Designing Organizational Architecture
Chapter 11: Organizational Architecture 351
The Fundamental Problem 353
Architecture of Markets 353
Architecture within Firms 354
Architectural Determinants 356
Changing Architecture 360
Interdependencies and Complementarities within the Organization
361
Corporate Culture 363
When Management Chooses an Inappropriate Architecture 367
Managerial Implications 368
Evaluating Management Advice 369
Benchmarking 369
Summary 370
Chapter 12: Decision Rights: The Level of Empowerment 373
Assigning Tasks and Decision Rights 374
Centralization versus Decentralization 377
Benefits of Decentralization 377
Costs of Decentralization 379
Illustrating the Trade-offs 382
Management Implications 386
Lateral Decision-Right Assignment 389
Assigning Decision Rights to Teams 390
Benefits of Team Decision Making 390
Costs of Team Decision Making 392
Management Implications 392
Decision Management and Control 394
Decision-Right Assignment and Knowledge Creation 396
Influence Costs 397
Summary 400
Appendix: Collective Decision Making 404
Chapter 13: Decision Rights: Bundling Tasks into Jobs and
Subunits 407
Bundling Tasks into Jobs 408
Specialized versus Broad Task Assignment 408
Productive Bundling of Tasks 412
Bundling of Jobs into Subunits 414
Grouping Jobs by Function 414
Grouping Jobs by Product or Geography 416
Trade-offs between Functional and Product or Geographic Subunits
416
Environment, Strategy, and Architecture 419
Matrix Organizations 420
Mixed Designs 422
Network Organizations 422
Organizing within Subunits 423
Recent Trends in Assignments of Decision Rights 423
Summary 428
Appendix: Battle of the Functional Managers 432
Chapter 14: Attracting and Retaining Qualified Employees 434
Contracting Objectives 436
The Level of Pay 436
The Basic Competitive Model 436
Human Capital 437
Compensating Differentials 439
Costly Information about Market Wage Rates 441
Internal Labor Markets 442
Reasons for Long-Term Employment Relationships 443
Costs of Internal Labor Markets 444
Pay in Internal Labor Markets 445
Careers and Lifetime Pay 445
Influence Costs 450
The Salary–Fringe Benefit Mix 450
Employee Preferences 451
Employer Considerations 453
The Salary–Fringe Benefit Choice 453
Summary 459
Chapter 15: Incentive Compensation 464
The Basic Incentive Problem 465
Incentives from Ownership 468
Optimal Risk Sharing 469
Effective Incentive Contracts 471
Principal-Agent Model 472
Informativeness Principle 477
Group Incentive Pay 478
Multitasking 480
Forms of Incentive Pay 481
Incentive Compensation and Information Revelation 482
Selection Effects of Incentive Contracts 483
Does Incentive Pay Work? 484
Summary 489
Appendix: Multitasking Theory 494
Chapter 16: Individual Performance Evaluation 498
Setting Performance Benchmarks 501
Time and Motion Studies 502
Past Performance and the Ratchet Effect 502
Measurement Costs 504
Opportunism 506
Gaming 507
Horizon Problem 508
Relative Performance Evaluation 508
Within-Firm Performance 508
Across-Firm Performance 510
Subjective Performance Evaluation 510
Multitasking and Unbalanced Effort 511
Subjective Evaluation Methods 512
Problems with Subjective Performance Evaluations 514
Combining Objective and Subjective Performance Measures 517
Team Performance 518
Team Production 519
Evaluating Teams 521
Government Regulation of Labor Markets 522
Summary 524
Appendix: Optimal Weights in a Relative Performance Contract 530
Chapter 17: Divisional Performance Evaluation 534
Measuring Divisional Performance 536
Cost Centers 536
Expense Centers 539
Revenue Centers 540
Profit Centers 541
Investment Centers 541
Transfer Pricing 546
Economics of Transfer Pricing 547
Common Transfer-Pricing Methods 552
Reorganization: The Solution If All Else Fails 556
Internal Accounting System and Performance Evaluation 557
Uses of the Accounting System 557
Trade-offs between Decision Management and Decision Control 558
Summary 561
Capstone Case Study on Organizational Architecture:
Arthur Andersen LLP 568
Part 4: Applications of Organizational Architecture
Chapter 18: Corporate Governance 575
Publicly Traded Corporations 577
Corporate Form of Organization 577
Stock Exchanges 578
Stock Ownership Patterns 578
Governance Objectives 579
Separation of Ownership and Control 580
Incentive Issues 580
Survival of Corporations 580
Benefits of Publicly Traded Corporations 581
Top-Level Architecture in U.S. Corporations 582
Sources of Decision Rights 583
Shareholders 584
Board of Directors 589
Top Management 592
External Monitors 596
International Corporate Governance 599
Market Forces 602
Sarbanes-Oxley Act of 2002 604
Corporate Governance: An Historical Perspective 606
Summary 607
Appendix: Choosing among the Legal Forms of Organization 612
Chapter 19: Vertical Integration and Outsourcing 623
Vertical Chain of Production 625
Benefits of Buying in Competitive Markets 628
Reasons for Nonmarket Transactions 629
Contracting Costs 629
Market Power 632
Taxes and Regulation 634
Other Considerations 635
Vertical Integration versus Long-Term Contracts 635
Incomplete Contracting 636
Ownership and Investment Incentives 636
Specific Assets and Vertical Integration 637
Asset Ownership 641
Other Reasons 641
Continuum of Choice 643
Contract Duration 644
Contracting with Distributors 645
Free-Rider Problems 645
Double Markups 646
Regulatory Issues 650
Trends in Outsourcing 651
Summary 654
Appendix: Ownership Rights and Investment Incentives 659
Web Chapter 20: Leadership: Motivating Change within
Organizations 663
Leadership 20-3
Vision Setting 20-3
Motivation 20-4
Decision Making within Firms 20-5
Incentive Problems and Organizational Politics 20-5
Understanding Attitudes toward Change 20-6
Changing Organizational Architecture 20-7
Proposal Design 20-9
Maintaining Flexibility 20-9
Commitment 20-10
Distributional Consequences 20-10
Marketing a Proposal 20-11
Careful Analysis and Groundwork 20-11
Relying on Reputation 20-11
Emphasizing a Crisis 20-13
Organizational Power 20-14
Sources of Power 20-14
Tying the Proposal to Another Initiative 20-17
Coalitions and Logrolling 20-18
Is Organizational Power Bad? 20-19
The Use of Symbols 20-20
Summary 20-21
Appendix: Strategic Value of Commitment and Crisis 20-23
Chapter 21: Understanding the Business Environment: The
Economics of Regulation 664
Importance of Regulation to Managers 665
Economic Motives for Government Intervention 666
Defining and Enforcing Property Rights 666
Redressing Market Failures 669
Redistributing Wealth 675
Economic Theory of Regulation 677
Demand for Regulation: Special Interests 677
Supply of Regulation: Politicians 677
Market for Regulation 680
Deadweight Losses, Transaction Costs, and Wealth Transfers 682
Managerial Implications 683
Restricting Entry and Limiting Substitutes 683
Forming Coalitions 686
On Business Participation in the Political Process 686
Summary 688
Chapter 22: Ethics and Organizational Architecture 691
Ethics and Choices 694
Corporate Mission: Ethics and Policy Setting 696
Ethics 696
Value Maximization 697
Corporate Social Responsibility 698
Economists’ View of Social Responsibility 700
Corporate Policy Setting 702
Mechanisms for Encouraging Ethical Behavior 705
Contracting Costs: Ethics and Policy Implementation 708
Codes of Ethics 710
Altering Preferences 712
Education 713
Corporate Culture 714
Summary 716
Web Chapter 23: Organizational Architecture and the Process of Management Innovation 721
Management Innovations 23-3
The Demand for Management Innovations 23-5
The Rise of TQM 23-6
Other Innovations 23-7
Why Management Innovations Often Fail 23-8
Marketing 23-8
Underestimating Costs of Change 23-11
Failure to Consider Other Legs of the Stool 23-12
Managing Changes in Organizational Architecture 23-16
Summary 23-19
Index 722
Web Glossary G-1