Specific and General Knowledge and

Organizational Structure

• Turner Company has three divisions, A, B, and C. Each division manufactures and sells a different product. Central management is currently debating how it desires to restructure decision-making authority within the firm. Currently, decision-making is highly centralized. Jensen and Meckling (1990) provide insight into this debate.

General and Specific Knowledge

• _________ knowledge is knowledge that is costly to transfer among agents

• _________ knowledge is inexpensive to transfer

• So what?___________ (the rights to decide on and take actions)are transferred to the location of specific knowledge when __________ knowledge is expensive to transfer.

Kinds of knowledge

• ___________• ___________• ___________

• Into which category would accounting fall?

In the case of Turner Co……

• Just transfer decision rights to the divisions when the divisions have specific knowledge relating to the decisions under consideration, maintain decision rights with central management when the decisions under consideration require general knowledge or specific knowledge that only central management possess, right?– Not that simple!

Decision rights• What does the previous scenario fail to consider?

– It addresses the rights assignment problem: who should exercise a decision right

– It does not address the __________ problem: how to ensure that self-interested agents exercise their rights in a way that contributes to the organizational objective.

• How do capitalist economic systems solve the control/agency problems?

– By granting ___________ of decision rights

• What is alienability? The right to sell a right and capture the proceeds offered in the exchange.

– It controls behavior via the construct of _________ (which represent the present value of claims to future flows of revenue or consumption services). How? Market prices

• 1) provide measures of performance of those who have the rights to decide how the asset or assets will be used

• 2) provide the reward or punishment that accrues to the owners of the rights as a result of their decisions

When decision rights are transferred without alienability.

• What result?

• What are the critical functions of alienability?– Collocation of decision rights and

relevant knowledge– Collocation of decision rights,

performance measurement, and the rewards and punishments of performance.

• Control systems take the place of alienability.

Control systems . . .• Provides performance measurement

and evaluation for each subdivision of a firm and each decision agent

• Rewards and punishes

Rules of the game

• What are the components of the concept that Jensen and Meckling refer to as the “rules of the game”?

a) The ____________________, and

b) The control system/s with___________________________________________________________________________________________________.

When will organizations form?

• Firms as we know them would not exist if alienability of all decision rights were granted to each agent along with the rights.

• So . . . Why do we see firms?

• They must obtain significant advantages from suppression of alienability.– ______________________– ______________________

In a firm . . .

• The principal cannot rely on alienability of decision rights to solve agency problems.

• A control system takes the place of alienability by performing its critical functions.

• Control is the process and rules governing the measures of performance and the rewards and punishments meted out in response to individual actions.

• Agency costs are the sum of the costs of designing, implementing and maintaining appropriate incentive and control systems.

• Solve the knowledge problems with decentralization, which creates agency problems.

• Solve the agency problems using costly control systems (policies, procedures, incentive contracts)

• How decentralized should an organization be?

• Decentralize to the point where the marginal benefit from saving information transfer costs just _______ the marginal cost of increasing agency problems.

Budgeting

• How are budgets using to solve agency problems?

• What’s the difference between a fixed budget and a variable budget?

• What are line budgets?• What are side constraints?• Why is minimizing average unit cost in

the absence of a quantity constraint almost never optimal?

The end!