Transcript Session 8 Incentives & Control

Incentives & Control
Question
What great document was
written in 1776?
Question
Why are some countries
rich and some poor?
Answer
The 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
RE
O
F
BE
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)
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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
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Stockholders
Board of Directors
Senior management
Middle managers
Line employees
Customers
SFA
CSS
CRM
Agency Sources
1. Potential divergence of interest
2. Basis of gainful exchange or
transaction
3. Difficulties in monitoring and
enforcing
4. You do not bear the full consequences
of your actions
Solutions
Internal
•
Improve monitoring
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Explicit incentive contracts. Linking pay to some operational
output – bonuses, options.
Achieving goal congruence – equity positions
•
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Peer Approval
Signalling!!!!
External
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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?
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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 & Partnership
complementary 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
Where to place decision rights?
Bird’s eye coordination
Centralized
Decision
Information
Costs
Agency
Costs
Decentralized
Local information
Where combined costs (Int CC) are minimized
Internal Coordination Costs
Internal
Coordination
Costs
Hierarchical Coordination
Agency
Monitoring costs
Costs
Bonding costs
Residual loss
Decision
Information
Costs
Information processing costs
Communication
Documentation
Opportunity costs due to poor information
External Coordination Costs?
External
Coordination
Costs
Market Coordination
Search costs
Transportation costs
Operational
Inventory holding costs
Communication costs
Costs of writing contracts
Costs of enforcing contracts
Contractual
Optimal Firm Size
Total Cost
Internal
Coordination &
Operations
Costs
Transaction
Costs
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)
The IS Problem
There are two immediate options when
attempting to co-locate knowledge and
decision rights.
1. Moving the knowledge to those who make
decisions
2. Move the decision rights to those who have
the knowledge
Consequences
1. A centralized system of control leads to high
information transferal costs and low agency
costs
2. A decentralized system leads to high agency
costs and lower information costs
The IS Problem: Who cares???
Affects issues of:
1.
2.
3.
4.
Organization
Geographic location
Process definition and standardization
“Virtual” value chain coordination
Dependant upon:
1.
2.
3.
4.
Uncertainty
Task definition
Interdependence
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 community
7. 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 hazard
Solutions
 Codify all alternatives in IT system, thus
preempting uncertainty (dangerous)
 Alternative, local governance mechanisms: e.g.
teams
Across the hierarchy
ALKA Old sales process
Alka HQ
sales lead
list
register/sen
d policy
specialist
Alka Regional office
(Sales person)
confirm
information
contact
customer
(Admin. processor)
NO
contact
salesperson
NO
Control
information
Information
OK?
contact
customer
YES
NO
YES
Specialist
required?
NO
register
customer
Customer
register
information
sales
meeting
sell policiy
confirm
information
Policy
ALKA New sales process
Alka HQ
NO
accept
call
register
information
input cust.
data in system
Specialist
required?
send policy
YES
specialist
Customer
contact
customer
Policy
Sales process reduced from 60 to 29 possible steps
ALKA Old claims adjustment
Alka HQ
send claims
form
evaluate
case
request
adjustor
evaluate
case
YES
Alka Claims Admin.
record
information
request
specialist
Info.
OK?
control
information
NO
input case
data in system
coverage?
exam by
adjustor/
specialist
payment/
close case
NO
request
additional
information
Customer
contact
Alka
claims form
return
claims form
written denial
payment
archive
ALKA New claims adjustment
Alka HQ
request
specialist
evaluate
case
request
adjustor
evaluate
case
YES
Alka Claims Admin.
record
information
Info.
OK?
input case
data in system
coverage?
exam by
adjustor/
specialist
payment/
close case
archive
NO
Customer
contact
Alka
verbal denial
(telehone)
payment
Claims administration reduced from 139 to 44 possible steps
Paper 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
RIVALRY
COOPERATION
COOPERATION
COOPERATION
COOPERATION
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
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