Managerial Economics & Organizational Architecture

by James A. Brickley, Clifford W. Smith, Jerold Zimmerman

Brickley/Smith/Zimmerman's new approach to managerial economics takes models from recent economics research and applies this research to the internal structure of the firm. After teaching basic applied economics, the authors look inside the firm and apply this analysis to management decision making. The general model used for this application is organizational architecture. Organizational architecture consists of three aspects of corporate the assignment of decision rights within the company; methods of rewarding individuals; and the structure of systems to evaluate the performance of both individuals and business units. These three components can be likened to a stool with three legs. If one of the legs is shorter, the stool is out of balance. These three elements must be in balance in an organization as well.

Genres: Economics, Reference, Management, Business, Nonfiction, Textbooks

704 pages, Hardcover

First published January 1, 1996

Reviews

[Dorotea · Rating 4 out of 5]

>Principal-agent framework: organizational variables (task allocation, job design, performance measures, reward systems) are structured to affect the worker’s preferred action and align it as much as possible to the principal’s interest. The agent can induce first-best behaviour by letting the worker being the residual claimant over profit and charging the worker for the right to work. However, this is not the case if the worker is financially constrained or if it is risk averse, or if performance measures are imperfect – in which case providing incentives is costly for the firm.
>Horizontal externalities: maximising own profits leads to too low prices of substitutes and too high prices of complements. To mitigate the problem the right to take the decision can be transferred to a higher level in the organization whose objective is to maximise joint profits (centralization), however this might lead to loss of local information. Another possible solution is to incorporate the performance of other division in the manager’s pay, but this might dilute the manager’s incentive and make it costlier to provide incentives.
>Vertical externalities: the golden rule (transfer price equal to the opportunity cost) makes sure that downstream makes the right production decision but it may distort upstream’s incentives to make other decisions – the general manager may set a transfer price different from opportunity cost to balance the incentives for different decisions or set the price equal to the opportunity cost and manage the weakness by monitoring upstream’s decision, or otherwise centralize the production decision
>The strategic effect of incentive schemes, when incentivizing managers on the basis of revenues rather than on profits, in a game of strategic substitutes (quantity competition) the direct effect is negative, but the strategic effect is positive, while in a game of strategic complements (price competition) the direct effect is negative and so is the strategic one. The same applies with self-cannibalization, while the opposite is true for higher transfer prices. Generally, with strategic substitutes, the competitors’ response to my more aggressive move is being less aggressive, while with strategic complements the competitor response is being more aggressive.
>Notes: (1) If benchmarking, pay attention to the Ratchet Effect: if principal increases performance standards for an agent in response to his good performance then that agent will not work as hard in anticipation (e.g. the Soviet 5-years plans’ goals) (2) Selection of workers happens as an indirect effect of performance pay and is as strong as the motivation effect.

[A Rye · Rating 4 out of 5]

The first book for the Managerial Economics class in my MBA program.
Well, the content is difficult, to be sure; however, this textbook does an outstanding job of explaining the ideas, and placing them in practical contexts. Unless you are interested in indifference curves, supply & demand, incentives, etc., though, I wouldn't pick it up.
As a textbook, it's probably one of the best I've ever had.

[Jena · Rating 3 out of 5]

I read this book for a course in my MBA program. The book is good; however, I wasn't a huge fan of the format of the book. I much rather would prefer if the detailed examples were at the back of the chapter rather than integrated into the text. More along the lines of the self-taught scenarios they have at the end of each chapter.

[Riley K. · Rating 4 out of 5]

Very informative