Managerial Decision Making and Incentive Structures

troškovna primjena??

How to use implications of multiple output cost functions?

Economies of Scope and Cost Complementarity

Economies of scope

• total cost of producing both products together is less than the total cost of producing both products separately

Implications for managerial decision making: managers alert to the possibility of profitably extending the product line to exploit economies of scope: reasons for mergers and acquisitions, reasons for not disinvesting a product line

Cost complementarity

• exists when the marginal cost of producing one output is reduced when the output of another product is increased:

Example of specialized investment

An investment in a particular exchange that cannot be recovered in another trading relationship

• Eg. Spending on a machine to test some device
• Useful only for testing the specific manufacturer’s device
• The investment is a sunk cost

Complex/uncertain environment? What method of procuring inputs should manager use?

• Produce inputs internally
• Vertical integration: Eg. Most automobile manufacturers make their own fenders from sheet steel and plastics
• Advantages: bypassing the service market, no need to rely on other firms
• Disadvantages: Capital necessary to set up production facilities, Loss of gains in specialization

Methods, Advantages and Disadvantages of Principal-Agent Problem

• In principal-agent relationship, there exists a problem in goals and interest differences
• Pricipal(shareholder)à not physically present, does not have control over the tasks his manager does, no monitoring, if loss occurs-who is to blame?
• Agent (manager)à can shirk instead of working and still receive fixed pay
• Solutions/methods:
• Incentive contracts: Stock options and other bonuses directly related to profits
• External incentives: Forces outside the firm provide managers with an incentive to maximize profits
• Reputation: Managers demonstrate that they have managerial skills needed to maximize profits – increased job mobility, Other firms may compete for the right to hire the best managers
• Takeovers: if a manager is not operating the firm in a profit-maximizing manner, investors will attempt to buy the firm and replace management with new ones

If a manager has fixed pay?

Manager: Shirking – long coffee breaks, lunch hours, not showing up…
Owner: Wants manager to work 8 hours per day

Managers receive fixed pay regardless of showing up or not
Extremes: profit 0, manager shrinks; profits $3 mil, manager works and monitors other people; profits $2.8 mil, manager shirks two hours.
Solution: offer a manager a compensation plan to receive 10% of profits

Why will the employees work poorly if they have a fixed salary?

Because they have an incentive to shirk, no matter what their performance is they will still get their salary which is the same if they put in effort.

How do I pay an employee on the assembly line?

Hourly wage – get more hours worked and a higher quantity overall – doesn't measure the actual productivity, only the hours on the job,

Amount of products assembled – ensure the highest productivity, worker will try to assemble as much as possible to obtain a higher salary – problem of exchanging quantity for quality.