Specific and General Knowledge and Organizational Structure

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Specific and General Knowledge and Organizational
Structure

• What is the difference between general and
  specific knowledge ?

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We know . . .

• What agency problems are
• What agency costs are
• That conflicts of interest create agency problems
  (moral hazard).
• That conflicts of interest are created when
  decision rights are delegated to individuals who
  are not also residual claimants
• And we know that agency problems can be mitigated
  (up to a point) with . . .

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More language . . .

• Decision rights vs. property rights in a
  capitalist system
• Alienability
• Residual claimant
• Decentralization
• Delegation
• Specific and general knowledge

Decision rights allocation problems and control
problems
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General and Specific Knowledge

• General knowledge is inexpensive to transfer,
• Specific knowledge is knowledge that is costly to
  transfer.
• So what?

Decision rights are transferred to the
locationof specific knowledge when relevant
knowledgeis expensive to transfer.
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Objectives to understand

• Alienability or control system
• General and specific knowledge and the
• Partitioning of decision rights
• Control systems . . .
• Which make up the rules of the game

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Control System

• Performance measurement system, and
• A system for reward and punishment.

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Alienable decision rights

• What is alienability?
• How does alienability solve the rights assignment
  problem in a market system?
• How does alienability solve the control problem
  in a market system?
• Why would firms suppress alienability?

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Kinds of knowledge

• Scientific
• Idiosyncratic
• Assembled
• Into which category would accounting fall?

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Inherit the firm.

• Junior inherits his familys helmet manufacturing
  factory on the untimely demise of his father. He
  has no experience running the firm.
• What are his decision rights in a private
  property economy?
• Plant managers knowledge . . .
• What should he do?
• What problems will he face if he decides to keep
  the residual claim (whats that?) and transfer
  decision rights to the plant manager?

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When decision rights are transferred without
alienability.

• What result?
• Control systems take the place of alienability.
• What are the critical functions of alienability?
• Co-location of decision rights and relevant
  knowledge
• Co-location of decision rights, performance
  measurement, and the rewards and punishments of
  performance.

Moral hazard
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Rules of the game

• What are the components of the concept that
  Jensen and Meckling refer to as the rules of the
  game?
• The partitioning of decision rights, and
• The control system/s performance measurement,
  evaluation, and a system of reward and punishment.

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Control systems . . .

• Performance measurement and evaluation for each
  subdivision of a firm and each decision
  agent(This specifies the objective function)
• Reward and punishments
• It does not take decision makers long to discover
  when the rewarded objective is different from
  that stated.

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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.
• Economies of scale or scope
• Reduced transactions costs

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A firm . . .

• In general, cannot rely on alienability of
  decision rights to solve agency problems.
• Uses a control system in place of alienability.
• Control is the process and rules governing the
  measures of performance and the rewards and
  punishments meted out in response to individual
  actions.

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Agency costs . . .

• Are the sum of the costs of designing,
  implementing and maintaining appropriate
  incentive and control systems.
• Arise when we solve the knowledge problems using
  decentralization, which creates conflicts of
  interest.
• We solve the agency problems using costly control
  systems (policies, procedures, incentive
  contracts)
• How decentralized should an organization be?

Decentralize to the point where the
marginalbenefit from saving information transfer
costsjust equals the marginal cost of increasing
agencyproblems.
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Discussion Question
What is the most centralized/hierarchicalstructur
e you can think of?
What kinds of organizations tend to adopt very
flat organizational structures?
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New York City Transit Police
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Budgeting

• How are budgets used to solve agency problems?
• Whats 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?

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Discussion Question

• XYZ Corporation has created an Officer of Energy,
  whose prime responsibility is to conserve energy
  used in heating and air conditioning the
  companys many buildings.
• The officer is not allocated a budget and does
  not have any formal voice in promotion or rewards
  of the managers of the producing divisions that
  occupy the buildings or the managers in charge of
  physical plant heating and air conditioning.
  Division managers are given a fixed budget and
  rewarded on the basis of output.
• Describe the organizational problems that are
  likely to occur with this arrangement. Explain
  why.

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You should . . .

• Be able to define general and specific knowledge
• Relate them to decision right partitioning
• Define alienabililty and control systems, and
• Explain how control systems take the place of
  alienability in organizations

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The end!