Essays on the economic theory of managerial incentives

Corporations are very common in the business world. In this kind of organizations shareholders are protected by limited liability and, furthermore, they can easily transfer their shares. As a consequence, investors might be interested in buying a corporation's shares just to diversify their portfolios, without any real interest in getting involved in management. It is therefore much easier for corporations to obtain external finance than other organizational forms, and this might well be the basic reason for their wide diffusion. For the very same reason, however, it is necessary to hire professional managers to make all the relevant decisions, and this contains the seed of their problematic governance. In fact, the separation of ownership and control produces a conflict of interest between shareholders, interested in maximizing the firm value, and managers, who can be interested in pursuing a variety of different objectives (empire building, entrenchment, shirking, etc.). This dissertation is composed by three research papers dealing with the economics of managerial incentive provision. It is common to interpret the relationship between shareholders and managers as an agency relationship affected by both a moral hazard and adverse selection problem. Usually, managerial incentives are affected by several elements such as, for example, their compensation packages and career concerns, the internal monitoring of the board of directors, the external monitoring of the market for corporate control, etc. This dissertation suggests that it might be necessary to consider Overview 2 the interactions between alternative incentive mechanisms both to better understand their functioning and, at least as importantly, to help interpreting empirical observations. The first chapter, Paying for Observable Luck, proposes a simple hidden action model which explains recent empirical evidence of asymmetric benchmarking in managerial compensation: managers appear to be insulated from bad luck but not from good luck. The explanation hinges on the interaction between explicit contractual incentives and implicit incentives deriving from the possibility of bankruptcy. The second chapter, Career Concerns and Competitive Pressure, studies how the level of competition in the product market a ects the strength of managerial career concerns. Good managers are in short supply so that firms are willing to compete for them. However, the value of good managers depends on the profit differential they are able to produce on the product market. It is then shown that increased competition makes career concerns stronger if it increases such profit differential. The third chapter, Managerial Entrenchment and the Market for CEOs, suggests that the observed trends of increased managerial pay and increased board independence might be related. Boards captured by an entrenched managers are not active on the demand side of the managerial labor market. Therefore, increased board independence, reducing the number of captured boards, also increases competition for good managers, then rising their pay and making their career concerns stronger

Where do we stand in the theory of finance? : a selective overview with reference to Erich Gutenberg

For the past 20 years, financial markets research has concerned itself with issues related to the evaluation and management of financial securities in efficient capital markets and with issues of management control in incomplete markets. The following selective overview focuses on key aspects of the theory and empirical experience of management control under conditions of asymmetric information. The objective is examine the validity of the recently advanced hypothesis on the myths of corporate control. The present overview is based on Gutenberg's position that there exists a discrete corporate interest, as distinct from and separate from the interests of the shareholders or other stakeholders. In the third volume of Grundlagen der BWL: Die Finanzen, published in 1969, this position of Gutenberg's is coupled with an appeal for a so-called financial equilibrium to be maintained. Not until recently have models grounded in capital market theory been developed which also allow for a firm's management to exercise autonomy vis-à-vis its stakeholder. This paper was prepared for the Erich Gutenberg centenary conference on December 12 and 13, 1997 in Cologne

Knowledge Management What Can Organizational Economics Contribute?

Knowledge management has emerged as a very successful organization practice and has been extensively treated in a large body of academic work. Surprisingly, however, organizational economics (i.e., transaction cost economics, agency theory, team theory and property rights theory) has played no role in the development of knowledge management. We argue that organizational economics insights can further the theory and practice of knowledge management in several ways. Specifically, we apply notions of contracting, team production, complementaries, hold-up, etc. to knowledge management issues (i.e., creating and integration knowledge, rewarding knowledge workers, etc.) , and derive refutable implications that are novel to the knowledge management field from our discussion.Transaction costs, organizational economics

Incentives and Human Resource Management in the Design of Public Sector Reform

We, in Pakistan, should be very happy that the global development community has finally accepted the centrality of public sector reform (also known as improved governance) in the quest for improved living standards in poor countries. Development economics is a subject that is based on the interpretation and observation of some Western academics and Western donor-based agencies. We should have some sympathy for these leaders of development thought and policy for they have struggled with integrating the prevailing theme (fad) in Western thought and philanthropy with learning about the societies and economies that they were supposed to be prescribing for. Using the principle of “ends justifying the means”, they defend their reliance on the current “fad” as well as on the only clearly visible, organised and powerful actor—the government, no matter how inefficient—they would. The result is that this approach led to a long era of government-led development, which centralised policy- and decision-making, initiated planning, and created a wide range of public-sector institutions. The role of the government was thus extended into areas that were conceptually indefensible. In this manner, the public servant grew into her new much more lustrous and looser robes. A bloated, over-centralised, and a private sector inhibiting government was created to be the observation and implementation outpost of the development word. This was the first step in the transformation of the public sector in the direction of misgovernance.

Microeconomic Policies in the New Economy

Competition policy, Technology policy, Network industries

Coordination under the Shadow of Career Concerns

To innovate, employees need to develop novel ideas and coordinate with each other to turn these ideas into better products and services. Work outcomes provide signals about employees' abilities to the labor market, and therefore career concerns arise. These can both be 'good' (enhancing incentives for effort in developing ideas) and 'bad' (preventing voluntary coordination). Our model shows how the firm designs its explicit incentive system and organizes work processes to take these conflicting forces into account. The comparative statics results suggest a link between the increased use of teams and recent changes in labor market returns to skills.career concerns, group incentives, knowledge work, reputation, teams

Resource allocation decisions under imperfect evaluation and organizational dynamics

Research and development (R&D) projects face significant organizational challenges, especially when the different units who run these projects compete among each other for resources. In such cases, information sharing among the different units is critical, but it cannot be taken for granted. Instead, individual units need to be incentivized to not only exert effort in evaluating their projects, but also to truthfully reveal their findings. The former requires an emphasis on individual performance, whereas the latter relies on the existence of a common goal across the organization. Motivated by this commonly observed tension, we address the following question: How should a firm balance individual and shared incentives, so that vital information is both acquired, and equally importantly, disseminated to the entire organization? Our model captures two key characteristics of R&D experimentation: information is imperfect and it is also costly. Our analysis yields several important implications for the design of such incentive schemes and the management of R&D portfolios

German technology policy, innovation, and national institutional frameworks

The pattern of innovation in Germany is substantially different from that in the US and the UK. It is argued that German patterns of innovation - incremental innovation in high quality products especially in engineering and chemicals - require long-term capital, highly cooperative unions and powerful employer associations, effective vocational training systems and close long-term cooperation between companies and with research institutes and university departments. (The more radical high-technology innovation typical of the US and the UK benefits by contrast from less regulated market conditions.) These conditions are met by the incentives and constraints of the institutional framework in which companies located in Germany are embedded. It is suggested that German technology policy is appropriate to and important for this pattern of high-quality incremental innovation. Moreover, the institutional framework - especially the role of powerful business associations - can solve the collective action problems to which German-type technology policy would normally be exposed. -- Die Entwicklungsvoraussetzungen für Innovationen in Deutschland unterscheiden sich substantiell von dem entsprechenden Muster in den USA oder in Großbritannien. In dem Papier wird die Meinung vertreten, daß die in Deutschland vorherrschenden Formen von Innovationen - Entwicklungen in kleinen Schritten bei technischen und chemischen Spitzenprodukten - langfristiges Kapital, sehr kooperative Gewerkschaften und mächtige Arbeitgeberverbände, ein effizientes Berufsausbildungssystem und eine enge langfristige Zusammenarbeit zwischen Unternehmen einerseits und Forschungsinstituten bzw. Universitätseinrichtungen andererseits voraussetzt. (Den für die USA und Großbritannien typischen hochtechnologischen Basisinnovationen sind im Gegensatz dazu geringer regulierte Marktbedingungen förderlich.) Diese Bedingungen werden durch die Anreize und Beschränkungen des Institutionengefüges, in dessen Rahmen die Unternehmen in Deutschland arbeiten, erfüllt. Es wird in dem Papier die These vertreten, daß die Technologiepolitik in Deutschland angemessen und wichtig für den beschriebenen Innovationstyp ist. Darüber hinaus kann das Institutionengefüge - vor allem die mächtigen Unternehmensverbände - die collective-action- Probleme lösen, denen die in Deutschland vorherrschende Technologiepolitik normalerweise ausgesetzt wäre.