JAMES A BRICKLEY CLIFFORD W SMITH JEROLD L ZIMMERMAN SIXTH EDITION MANAGERIAL ECONOMICS AND ORGANIZATIONAL ARCHITECTURE Managerial Economics and Organizational Architecture The McGraw-Hill Series in Economics ESSENTIALS OF ECONOMICS ECONOMICS OF SOCIAL ISSUES MONEY AND BANKING Brue, McConnell, and Flynn Essentials of Economics Third Edition Guell Issues in Economics Today Seventh Edition Cecchetti and Schoenholtz Money, Banking, and Financial Markets Fourth Edition Mandel Economics: The Basics Second Edition Sharp, Register, and Grimes Economics of Social Issues Twentieth Edition URBAN ECONOMICS Schiller Essentials of Economics Ninth Edition ECONOMETRICS PRINCIPLES OF ECONOMICS Colander Economics, Microeconomics, and Macroeconomics Ninth Edition Frank and Bernanke Principles of Economics, Principles of Microeconomics, and Principles of Macroeconomics Sixth Edition Frank and Bernanke Brief Editions: Principles of Economics, Principles of Microeconomics, and Principles of Macroeconomics 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School of Business Administration University of Rochester MANAGERIAL ECONOMICS AND ORGANIZATIONAL ARCHITECTURE, SIXTH EDITION Published by McGraw-Hill Education, Penn Plaza, New York, NY 10121 Copyright © 2016 by McGraw-Hill Education All rights reserved Printed in the United States of America Previous editions © 2009, 2007, and 2004 No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning Some ancillaries, including electronic and print components, may not be available to customers outside the United States This book is printed on acid-free paper QVS/QVS ISBN 978-0-07-352314-9 MHID 0-07-352314-3 Senior Vice President, Products & Markets: Kurt L Strand Vice President, General Manager, Products & Markets: Marty Lange Vice President, Content Design & Delivery: Kimberly Meriwether David Managing Director: James Heine Director, Product Development: Rose Koos Senior Brand Manager: Katie Hoenicke Lead Product Developer: Michele Janicek Senior Product Developer: Christina Kouvelis Director of Digital Content Development: Doug Ruby Director, Content Design & Delivery: Linda Avenarius Executive Manager: Faye M Herrig Content Project Managers: Mary Jane Lampe, Sandra Schnee Buyer: Carol A Bielski Cover Design: Studio Montage Content Licensing Specialist: Rita Hingtgen Cover Image: © Corbis / Glow Images Compositor: MPS Limited Typeface: 10.75/12 Adobe Garamond Printer: Quad/Graphics All credits appearing on page or at the end of the book are considered to be an extension of the copyright page Library of Congress Cataloging-in-Publication Data Brickley, James A Managerial economics and organizational architecture / James A Brickley, Clifford W Smith, Jerold L Zimmerman, William E Simon, Graduate School of Business Administration, University of Rochester.—Sixth edition pages cm.—(The McGraw-Hill series in economics) ISBN 978-0-07-352314-9 (alk paper) Managerial economics Organizational effectiveness I Title HD30.22.B729 2015 658—dc23 2014043202 The Internet addresses listed in the text were accurate at the time of publication The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites www.mhhe.com Dedicated to our children— London, Nic, Alexander, Taylor, Morgan, Daneille, and Amy PREFACE The past few decades have witnessed spectacular business failures and scandals In 2001 and 2002, Enron, WorldCom, Arthur Andersen, as well as other prominent companies imploded in dramatic fashion Internationally, scandals emerged at companies such as Parmalat, Royal Dutch Shell, Samsung, and Royal Ahold In 2007 and 2008, prominent financial institutions around the world shocked financial markets by reporting staggering losses from subprime mortgages Société Générale, the large French bank, reported over $7 billion in losses due to potentially fraudulent securities trading by one of its traders JPMorgan Chase bailed out Bear Stearns, a top-tier investment bank, following their massive subprime losses Washington Mutual and Lehman Brothers were added to the list of “top business failures of all time.” Due to these cases and others, executives now face a more skeptical investment community, additional government regulations, and stiffer penalties for misleading public disclosures A common perception is that bad people caused many of these problems Others argue that the sheer complexity of today’s world has made it virtually impossible to be a “good” manager These views have raised the cry for increased government regulation, which is argued to be a necessary step in averting future business problems We disagree with this view We suggest that many business problems result from poorly structured organizational architectures The blueprints for many of these prominent business scandals were designed into the firms’ “organizational DNA.” This book, in addition to covering traditional managerial economic topics, examines how firms can structure organizations that channel managers’ incentives into actions that create, rather than destroy, firm value This topic is critical to anyone who works in or seeks to manage organizations—whether for-profit or not-for-profit New Demands: Relevant Yet Rigorous Education Thirty years ago, teaching managerial economics to business students was truly a “dismal science.” Many students dismissed standard economic tools of marginal analysis, production theory, and market structure as too esoteric to have any real relevance to the business problems they anticipated encountering Few students expected they would be responsible for their prospective employers’ pricing decisions Most sought positions in large firms, eventually hoping to manage finance, operations, marketing, or information systems staffs Traditional managerial economics courses offered few insights that obviously were relevant for such careers But a new generation of economists began applying traditional economic tools to problems involving corporate governance, mergers and acquisitions, incentive conflicts, and executive compensation Their analysis focused on the internal structure of the firm—not on the firm’s external markets In this book, we draw heavily from this research and apply it to how organizations can create value through improved organizational design In addition, we present traditional economic topics—such as demand, supply, markets, and strategy—in a manner that emphasizes their managerial relevance within today’s business environment Today’s students must understand more than just how markets work and the principles of supply and demand They also must understand how self-interested parties within organizations interact, and how corporate governance mechanisms can control these interactions Consequently, today’s managerial economics course must cover a broader menu of topics that are now more relevant than ever to aspiring managers facing this post-Enron world Yet, to best serve our students, offering vi Preface vii relevant material must not come at the expense of rigor Students must learn how to think logically about both markets and organizations The basic tools of economics offer students the skill set necessary for rigorous analysis of business problems they likely will encounter throughout their careers Besides the heightened interest in corporate governance, global competition and rapid technological change are prompting firms to undertake major organizational restructurings as well as to produce fundamental industry realignments Firms now attack problems with focused, cross-functional teams Many firms are shifting from functional organizational structures (manufacturing, marketing, and distribution) to flatter, more process-oriented organizations organized around product or region Moreover, this pace of change shows no sign of slowing Today’s students recognize these issues; they want to develop skills that will make them effective executives and prepare them to manage organizational change Business school programs are evolving in response to these changes Narrow technical expertise within a single functional area—whether operations, accounting, finance, information systems, or marketing—is no longer sufficient Effective managers within this environment require cross-functional skills To meet these challenges, business schools are becoming more integrated Problems faced by managers are not just finance problems, operations problems, or marketing problems Rather, most business problems involve facets that cut across traditional functional areas For that reason, the curriculum must encourage students to apply concepts they have mastered across a variety of courses This book provides a multidisciplinary, cross-functional approach to managerial and organizational economics We believe that this is its critical strength Our interests span economics, finance, accounting, information systems, and financial institutions; this allows us to draw examples from a number of functional areas to demonstrate the power of this underlying economic framework to analyze a variety of problems managers face regularly We have been extremely gratified by the reception afforded the first five editions of Managerial Economics and Organizational Architecture Adopters report that the earlier editions helped them transform their courses into one of the most popular courses within their curriculum This book has been adopted in microeconomics, human resources, and strategy courses in addition to courses that focus specifically on organizational economics The prior editions were founded on powerful economic tools of analysis that examine how managers can design organizations that motivate self-interested individuals to make choices that increase firm value Our sixth edition continues to focus on the fundamental importance of markets and organizational design We use the failures of Enron (Chapter 1), Société Générale (Chapter 1), Arthur Andersen (Chapter 22), and Adelphia (Chapter 10) as case studies to illustrate how poorly designed organizational architectures can be catastrophic Other books provide little coverage of such managerially critical topics as developing effective organizational architectures, including performance-evaluation systems and compensation plans; assigning decision-making authority among employees; and managing transferpricing disputes among divisions Given the increased importance of corporate governance, this omission has been both significant and problematic Our primary objective in writing this book is to provide current and aspiring managers with a rigorous, systematic, comprehensive framework for addressing such organizational problems To that end, we have endeavored to write the underlying theoretical concepts in simple, intuitive terms and illustrate them with numerous examples—most drawn from actual company practice viii Preface The Conceptual Framework Although the popular press and existing literature on organizations are replete with jargon—TQM, reengineering, outsourcing, teaming, venturing, empowerment, and corporate culture—they fail to provide managers with a systematic, comprehensive framework for examining organizational problems This book uses economic analysis to develop such a framework and then employs that framework to organize and integrate the important organizational problems, thereby making the topics more accessible Throughout the text, readers will gain an understanding of the basic tools of economics and how to apply them to solve important business problems While the book covers the standard managerial economics problems of pricing and production, it pays special attention to organizational issues In particular, the book will help readers understand: • • • • • How the business environment (technology, regulation, and competition in input and output markets) drives the firm’s choice of strategy How strategy and the business environment affect the firm’s choice of organizational design—what we call organizational architecture How the firm’s organizational architecture is like its DNA; it plays a key role in determining a firm’s ultimate success or failure, since it affects how people in the organization will behave in terms of creating or destroying firm value How corporate policies such as strategy, financing, accounting, marketing, information systems, operations, compensation, and human resources are interrelated and thus why it is critically important that they be coordinated How the three key features of organizational architecture—the assignment of decision-making authority, the reward system, and the performance-evaluation system—can be structured to help managers to achieve their desired results Performance Evaluation (What are the key performance measures used to evaluate managers and employees?) Decision-Rights Assignment (Who gets to make what decisions?) Rewards (How are people rewarded for meeting performance goals?) The components of organizational architecture are like three legs of a stool It is important that all three legs be designed so that the stool is balanced Changing one leg without the careful consideration of the other two is typically a mistake These three components of organizational architecture are like three legs of the accompanying stool Firms must coordinate each leg with the other two so that the stool remains functional Moreover, each firm’s architecture must match its strategy; a balanced stool in the wrong setting is dysfunctional: Although milking stools are quite productive in a barn, tavern owners purchase taller stools Reasons for Adopting Our Approach This book focuses on topics that we believe are most relevant to managers For instance, it provides an in-depth treatment of traditional microeconomic topics (demand, supply, pricing, and game theory) in addition to corporate governance topics (assigning decision-making authority, centralization versus decentralization, measuring and Preface ix rewarding performance, outsourcing, and transfer pricing) We believe these topics are more valuable to prospective managers than topics typically covered in economics texts such as public-policy aspects of minimum-wage legislation, antitrust policy, and income redistribution A number of other important features differentiate this book from others currently available, such as: • • • • • • Our book provides a comprehensive, cross-functional framework for analyzing organizational problems We this by first describing and integrating important research findings published across several functional areas, then demonstrating how to apply the framework to specific organizational problems This text integrates the topics of strategy and organizational architecture Students learn how elements of the business environment (technology, competition, and regulation) drive the firm’s choice of strategy as well as the interaction of strategy choice and organizational architecture Reviewers, instructors, and students found the prior editions accessible and engaging The text uses intuitive descriptions and simple examples; more technical material is provided in appendices for those who wish to pursue it Numerous examples drawn from the business press and our experiences illustrate the theoretical concepts For example, the effect of the 9/11 terrorist attacks on demand curves is described in Chapter and how one devastated company located in the World Trade Center responded is discussed in Chapter 14 These illustrations, many highlighted in boxes, reinforce the underlying principles and help the reader visualize the application of more abstract ideas Each chapter begins with a specific case history that is used throughout the chapter to unify the material and aid the reader in recalling and applying the main constructs Nontraditional economics topics dealing with strategy, outsourcing, leadership, organizational form, corporate ethics, and the implementation of management innovations are examined Business school curricula often are criticized for being slow in covering topics of current interest to business, such as corporate governance The last six chapters examine recent management trends and demonstrate how the book’s framework can be used to analyze and understand topical issues Problems, both within and at the end of chapter, are drawn from real organizational experience—from the business press as well as our contact with executive MBA students and consulting engagements We have structured exercises that provide readers with a broad array of opportunities to apply the framework to problems like ones they will encounter as managers Organization of the Book • • Part 1: Basic Concepts lays the groundwork for the book Chapter summarizes the economic view of behavior, stressing its management implications Chapter presents an overview of markets, provides a rationale for the existence of organizations, and stresses the critical role of the distribution of knowledge within the organization Part 2: Managerial Economics applies the basic tools of economic theory to the firm Chapters through cover the traditional managerial-economics topics of demand, production and cost, market structure, and pricing These four chapters provide the reader with a fundamental set of microeconomic tools and www.downloadslide.net 738 Index Transportation costs, 175–176, 629 reduced by Ford and General Motors, 283–284 reduced by Internet, 262 Transportation Security Administration, 417, 686 Travelers Insurance Company, 685 Treasury note auction, 684–685 Tredwell, Jay, 551 Trilogy Software, 41 Tucker, R., 675 Tuition pricing, 236 Tully, S., 137, 588 TurboTax, 223, 240, 244–245 Two-part pricing, 641 Two-part tariff, 233–234 for capital goods, 235 Tyco International, 579, 609, 694 scandal, Tying arrangements, 248 Tylenol tragedy, 708–709 U S Navy, 637 UBS, 89, 384, 579 Ujiie, Junichi, 280 U.K Auto Producers new technology rejuvenates, 428 Ulhoi, J., 426n Uncertain environments, 630 Uncertainty asset specificity and, 631 decisions making under, 38–41 Underhill, Paco, 138 Unilever, 272, 306 Unions and vertical integration and contracting, 633 Unitary demand, 127 Unitary form (U form) of organization, 417 Unit cost, 169 United Airlines, 201, 208, 212, 247, 297, 333 online pricing errors, 123 United Banker’s Bank, 634 United Cigar Stores, 263 United Parcel Service, 271, 462, 583 United States animosity toward Venezuela, 70 demand for prostitutes in, 140 Global Entry Program, 262 lagging in worker skills, 443 United Technologies, 377 Universal Music Group, 249 Universities influence costs in, 454 pay in, 454 University of Notre Dame, 124 University of Richmond, 124 Unprofitable customers, 17 Unrelated diversification, 285 Upstream integration, 618 Ursinus College, 124 U.S airlines lack of profitability, 173 U.S Department of Agriculture, 697 U.S Department of Justice, 315, 330, 579, 588, 626–627, 655, 656, 664, 685 U.S Department Veterans Affairs, 540 U.S Food and Drug Administration, 691, 695 U.S law, 697 U.S Mint, 19 U.S securities laws, 666 U.S Sentencing Commission, 704 U.S steel industry, 678 U.S Supreme Court rules in favor of selling imports of copyrighted items, 235 U.S tax code, 526 U.S tobacco industry, 272 Used car market, 347 U-shaped cost curves, 170 Utility, 20 and slope of indifference curve, 50–51 Utility function, 20–21 and indifference curves, 21–22 of stock analysis, 28–30 Utility functions forms of, 49 ordinal vs cardinal ranking, 49 Utility maximization, 20n, 52 Utility-to-price ratio, 52, 53 V A hospitals performance measures, 540 Valdmanis, T., 422 Value, capturing, 269–282 ability of firms, 290 in face of change, 281 failure by Eli Whitney, 270 market power, 270–272 Polaroid’s success and failure, 282 superior factors of production, 273–277 Walmart’s success, 278–280 Value, consumer and producer surplus, 260 Value creation, 259–269 by converting organizational knowledge, 266–267 cooperation for, 265–266 demand and supply curves, 259–260 by diversification, 285 by Eli Whitney, 270 gains from trade and, 75 general means of, 260 by increasing demand, 262–265 from new products/services, 265 opportunities, 267–269 reducing consumer waiting time, 261 reducing production costs, 261 by reducing transaction costs, 261–262 from technology, 265 total value, 260 Value maximization, 282, 349 ethics and, 690–692 compensating differentials, 691 economic Darwinism, 690 role for regulation, 690–691 Vancil, R., 453, 596n Van Horn, L., 636 Variability, 39 Variable costs, 172 retail pharmacies, 173 Variables influencing demand, 135 Varian, H., 236n, 251 Variance, 39 Variety of tasks, 378 Vasella, Daniel, 492 Vellequette, L., 315 Verbal contracts CEO’s view of, 703 Verizon Wireless, 212 Vertical chain of production, 282, 617–619 for personal computers, 617–618 Vertical integration in aerospace industry, 632 to avoid contracting with competitors, 634 versus long-term contracts, 627–635 asset ownership, 632–633 continuum of choice, 634–635 incomplete contracting, 628 other reasons, 633–634 ownership and investment incentives, 628–629 specific assets, 629–632 and price-discrimination, 625–626 Vertically integrated firms, 618 Videocassette recorders, 146 Videogames, 243 Vinson, Betty, 606 Violations insider-trading, 688 Virgin Atlantic Airlines, 261 Virtual vineyards, 237 Virtue, 689 Vishny, Robert W., 590n, 591 Vision Technologies, 137 Vivendi Universal, 249 Voluntary corporate liquidation, 290n Voreacos, D., 137 V-8 vegetable juice, 18 W L Gore & Associates, 516 Wages compensating differentials, 444–446 efficiency, 449–450 information about market rates, 446 and job risks, 445 minimum, effect on employment, 167 Waigaya, 376 Wakeman, L., 628n, 700 Waksal, Samuel, 688 Walczak, L., 671 Walgreens, 173, 691 Walker, M., 308 Wall Street Journal, 133, 203, 279, 578, 606, 669, 698, 700 Walmart, 235, 281, 390, 393, 537, 580 diversification by, 283 explanation of success, 278–280 first-mover advantages, 312 focus of strategy, 258–259 holiday season 2007, 281 www.downloadslide.net Index international locations, 279 online pricing errors, 123 reduced transaction costs, 261–262 rural-urban differences, 279 strategy, 257–258 supercenters and demand elasticities for grocery products, 125 Walmart.com, 289–290 Walt Disney Company, 137 Walton, Sam, 257, 278 Wants, 15 War, and hunger, 659 Warburg Asset Management, 684 Warehouses (Amazon), 158 Warnaco, 400 Warner, J., 370n Warner, M., 137 Warner Brothers, 217 Warner Music, 249 Warranties, 700 Washington lobbyists, 671 Washkewicz, Donald, 230 Watts, R., 370n, 401, 557n, 595n, 597n, 675 Wealth constraints on ownership incentive, 474 The Wealth of Nations, 413, 584 Wealth transfers, examples of, 667–668 Webb, E., 142n Weisbach, M., 370n, 594n, 597n Welch, Jack, 519 Wells Fargo, 281 Wendy’s, 261, 267, 696 Werhane, P., 711 Wessel, D., 417 Western coal producers, 678 Weston, J., 587n, 605n Wexler, C., 193n Whinston, M., 647 Whitacre, Mark, 217 Whitford, D., 282, 438n Whitney, Eli, 270 Widely held corporation, 581 Wilke, J., 655n Williams, M., 348, 376n Williamson, O., 5n, 107, 422n, 434, 622n, 632, 647 Willig, R., 5n, 270n Wilmorite Corporation, 693 Wilson, George, 691 Wimbledon tennis tournament, 308 Windows computers, 138 Wingfield, N., 246 Wireless phone companies, 212 Within-firm performance, 512–513 Wolfson, M., 333, 459n, 550n, 626n Wooders, J., 308 Woodruff, D., 376n Woodruff, Michael, 336 Worker Safety Rules, 680 Workforce skills, 443 Workplace, comparative advantage in, 75 Work sampling, 506 World Acceptance Corp., 31 WorldCom, 8, 14, 578–579, 583, 584, 586, 589, 592, 596, 606 World Motors (WM), 680 World Trade Center attack, 137, 262 Wrigley, A., 157n Wrong behaviors, 687 Wruck, K., 370n Wu, J., 600n Wulf, J., 396, 419, 431 739 X box One, 616 Xerox Corporation, 9, 247–248, 281, 286, 297, 363, 370, 400, 485, 643 Xie, J., 514n Xoceco Inc., 203 Y ahoo!, 99 Yellen, J., 450n Yermack, D., 592n Yohe, G., 127, 133, 134 Young, G., 503 YouTube, 629 Z antac, 550 Zellner, W., 290 Zero economic profit, 207–208 Zhang, I., 607 Zhang Bengjun, 10 Zimmerman, J., 5n, 401, 549n, 559n, 560n, 566, 675, 684 Zingales, L., 369 Zwiebel, J., 413n www.downloadslide.net Glossary* A bsolute performance evaluation is based on a predetermined standard of performance—see relativeperformance evaluation average cost (AC) is the total cost divided by total output; average cost can be defined for either the long run or the short run activity-based costing (ABC) assigns different categories of overhead (purchasing, engineering, inspection) costs to products by first estimating the underlying cost drivers of the activities performed within the overhead department and then assigning these activity costs to the products that benefit from or consume these resources average product (AP) of an input is the total product divided by the quantity of the input employed adverse selection refers to the tendency of individuals with private information about factors that affect a potential trading partner’s benefits to make offers that are detrimental to the trading partner—see precontractual information problems ackward integration occurs when an organization produces its own inputs—also called upstream integration agency relationship is an agreement under which one party, the principal, engages another party, the agent, to perform some service on the principal’s behalf average revenue (AR) is the total revenue divided by total output B bargaining failures occur due to asymmetric information; parties fail to reach an agreement, even when in principle a contract could be constructed that would be mutually advantageous—see precontractual information problems alienable property rights are private property rights that can be transferred (sold or given) to other individuals barriers to entry are factors that limit the entry of new firms to a market, even though the existing firms are making economic profits arbitrage is a simultaneous set of transactions designed to make profits without risk (for example, if equivalent assets are traded in two markets, buying at the lower price and selling at the higher price) benchmarking is identifying the best practices of firms operating within similar environments, so that the benchmarking firm can learn from the experience of the others arc elasticities are estimated between two points (elasticities also can be calculated at a point); they relate the percentage change in one variable, such as quantity, to a percentage change in another variable, such as price Bertrand model examines producer interaction, assuming each firm treats the product price chosen by its competitors as fixed and then decides how to set its price—see oligopolistic market asset specificity occurs when a given asset is especially useful to one or to a small number of buyers—for physical assets, this results from product design or site specificity; for human capital, it results from investments in specialized knowledge or skills blockholder is a name given to the holder of a “large” amount (at least percent of the outstanding shares) of common stock asymmetric information occurs when one party to a transaction has information different from that of another party audit committee is a committee of the board of directors responsible for oversight of the financial reporting process, selection of the independent auditor, and receipt of audit results block pricing sets a high price for the first unit or block of units purchased and lower prices for subsequent units or blocks boundary setting occurs when managers empower employees to make decisions within prespecified limits brand-name capital refers to a firm’s intangible reputational capital; by establishing a reputation for quality products or living up to its end of a contract, the firm can receive more favorable terms from contracting parties because it is a more desirable partner *Italicized terms are defined elsewhere in the glossary G-1 www.downloadslide.net G-2 Glossary broad task assignment has individual employees performing a relatively large set of tasks—see specialized task assignments changes in the quantity demanded are movements along a demand curve that are motivated by changes in the good’s own price, holding all other factors constant bundling occurs when a company packages two or more products together and offers the package for sale as a unit civil law is based on a series of written codes or laws and constitutes the basis for the legal systems in various countries such as Germany and France business environment includes the technology, markets (product and input), and regulations facing the firm business ethics is the study of behaviors that businesspeople should and should not follow (however, this term also is used in a variety of ways that range from making firms socially responsible to attempting to induce employees to ignore their self-interest) business judgment rule states that in the absence of bad faith or some other corrupt motive, directors are normally not liable to the corporation for mistakes of judgment The rule has functioned as a barrier to prevent courts from exercising regulatory powers over the activities of corporate managers business norms are expectations in market transactions that not have the force of law, yet nonetheless represent expected behavior business strategy focuses on strategy at the business-unit level; the primary consideration is whether to focus on being the low-cost producer in an industry or to develop differentiated products for which customers are willing to pay a price premium C corporations are the most common form of organization among large companies; income faces double taxation; shareholders have limited liability; there are few restrictions on the number or type of shareholders that can own stock in the firm—see S corporations cafeteria-style benefit plans are plans in which individual employees allocate a fixed-dollar fringe-benefit allowance among a variety of choices—also called menu plans career earnings are the total wages that employees expect to earn over their entire careers cartels consist of formal agreements among a set of firms to cooperate in setting prices and output levels centralized decision system is one that assigns the most important decisions to senior executives within the organization certainty equivalent is the certain income that an individual considers equivalent to an activity with risky payoffs changes in demand are movements of the demand curve motivated by factors other than changes in the good’s own price (such as changes in income or changes in the prices of related goods) closely held corporations are characterized by stock that is not freely traded and often held by only a few shareholders (often within the same family) Coase Theorem states that the ultimate resource allocation will be efficient, regardless of the initial assignment of property rights, as long as contracting costs are sufficiently low, property rights are assigned clearly, and these rights can be exchanged readily common law is unwritten law developed primarily from judicial case decisions based on custom and precedent It developed in England and constitutes the basis for the legal systems of most of the states in the United States common stock represents equity claims held by the “residual owners” of the firm They are the last in line to receive any distribution of earnings or assets comparative advantage occurs when one party can produce a good relatively more efficiently than other parties (relative efficiency means that alternative products which could have been produced from the same inputs are less valuable) It is conceptually possible for a party to have an absolute advantage in producing all goods (meaning that it can produce all goods with fewer inputs); however, it cannot have a comparative advantage in all goods Aggregate output is higher if parties specialize in producing products in which they have a comparative advantage compensating wage differential is the extra wage that is paid to attract an individual to a less desirable job competitive market is a market structure in which no buyer or seller has market power (all trades are made at the going market price); it is characterized by a large number of potential buyers and sellers, low costs of entry and exit, product homogeneity, and rapid dissemination of accurate information at low cost complementarities exist when doing more of one activity either increases the benefits or reduces the costs of doing another activity complements are products that tend to be consumed together; a price reduction of one good tends to increase the quantity demanded of the other good complete contracts are contracts that specify exactly what is expected of each party under all possible future contingencies www.downloadslide.net Glossary G-3 constant returns to scale for a production function occur when a percent change in all inputs results in percent change in output cost-plus pricing is where firms set prices by marking up average total cost by an amount designed to yield a target rate of return consumer surplus is the difference between the maximum amount a consumer would be willing to pay for a product and what the consumer actually pays when buying it Cournot model examines producer interaction, assuming each firm treats the output level of its competitors as fixed and then decides how much to produce—see oligopolistic market contracting costs are the out-of-pocket and opportunity costs of negotiating, drafting, and enforcing contracts; they include search and information costs, bargaining and decision costs, and policing and enforcement costs, and the efficiency losses that result because incentive conflicts are not completely resolved contracting problems occur within contracts because individuals have incentives to take actions that increase their well-being at their contracting partner’s expense; they occur within both explicit and implicit contracts control system encompasses the reward and performance evaluation systems within the firm corporate culture is the set of explicit and implicit expectations of behavior within the firm; it usually encompasses the ways work and authority are organized, the ways people are rewarded and controlled, as well as organizational features such as customs, taboos, company slogans, heroes, and social rituals corporate governance is a popular term that is used to describe organizational architecture at the top of a corporation Corporate governance focuses on the allocation of decision rights among the shareholders, board of directors, top managers, and various external monitors (e.g., independent auditors, stock exchanges, governmental regulators, and financial analysts) and the associated incentives of these parties Corporate governance also encompasses the type and frequency of information corporations must disclose to various constituents corporate stakeholders is a term used to describe employees, banks, customers, communities, and other parties that are affected by the operations of a corporation corporate strategy focuses on strategy at the firm level; the primary consideration is the degree of corporate diversification chosen by the firm (the array of different products that the firm sells) corporation is a legal form of organization formed by filing the appropriate paperwork and fees with officials in the state of incorporation; has the legal standing of an individual (distinct from its shareholders) and can enter contracts, participate in lawsuits, and so on; corporations also have the right to issue stock and to exist indefinitely; shareholders have limited liability—see C corporations and S corporations cost centers are business units whose performance is evaluated based on their efficiency of production credit rating agencies rate the publicly traded debt of corporations in terms of the probability of default (e.g., Fitch, Moody, and Standard and Poor’s) cross elasticity relates the percentage change in the quantity of a good purchased to a percentage change in the price of some other good cross-training occurs when employees are taught to complete more than one task or function cumulative production is the total output produced by the firm across all previous production periods D eadweight loss involves the forgone gains from trade (for instance, the forgone producer and consumer surplus when a firm with market power sets price above marginal cost) decentralized system is one that assigns many important decision rights to lower-level employees decision control encompasses the ratification and monitoring of decisions decision management encompasses the initiation and implementation of decisions decision rights represent the authority to decide how resources will be used within the organization decreasing returns to scale for a production function occur when a percent change in all inputs results in a less than percent change in output dedicated assets are those whose purchase is necessitated by the requirements of one or only a few buyers demand curve displays the relation between the quantities of a product that will be purchased at each price over a stated period of time, holding all other factors fixed; demand curves slope downward because customers are more likely to purchase if the price is lower—see law of demand demand function is the relation between the quantity demanded for a product and all factors that influence its demand dominant strategies exist when it is optimal for a firm to choose a particular strategy no matter the choices of its rivals—especially used in game theory www.downloadslide.net G-4 Glossary double markups are the increments in the product’s price above marginal cost first by the manufacturer and then by the distributor; this problem occurs with decentralized pricing decisions when the producer has market power double taxation refers to the case with C corporations where income is taxed both at the corporate level when earned and at the personal level when distributed to the owners (shareholders) downstream integration—see forward integration dual-class shares are common stock shares issued for a single company with varying classes indicating different voting rights duopoly is a market setting in which two firms compete in a market—see oligopolistic market E conomic Darwinism is the economic counterpart of the biological theory of natural selection; an organization selects features that increase its ability to survive within its environment; the basic idea is that a competitive marketplace creates pressures that favor organizations that are relatively most efficient economic profit is an above-competitive (or extra-normal) rate of return on assets; economic profits are eroded in competitive markets Economic Value Added (EVA—registered trademark of Stern Stewart) is a measure of residual income; it is the after-tax operating profit of the division minus the total annual cost of capital invested in the division economies of scale occur in industries in which average cost declines over a broad range of output levels economies of scope occur when the cost of producing a set of products jointly within one firm is lower than the cost of producing the products separately across independent firms efficiency wages are wage premiums paid to reduce shirking because employees are afraid that if they are caught, they will be fired and lose this premium; efficiency wages also discourage employee turnover elastic demand occurs when the price elasticity is greater than one; in this case, a small increase in price decreases total revenue elasticity of demand relates the percentage change in the quantity demanded to a given percentage change in its price Higher price elasticities mean greater price sensitivity Although the law of demand implies that this ratio will be negative, convention dictates that this elasticity is stated as a positive number—also called price elasticity of demand equilibrium refers to a stable situation where no party has a reason to change its strategy (for example, in a competitive market, this occurs when the quantity supplied of a product equals the quantity demanded) ethics is the study of behaviors that people should and should not follow exclusive territories grant individual distributors the exclusive rights to operate within a specified market area expense centers are business units that are given fixed budgets and asked to maximize some hard-to-measure service or output; it is essentially a cost center that does not produce an easily measurable output experience goods are those that must be tried by the customer to ascertain quality explicit contracts are formal written agreements with a party related to the firm (for example, employees, customers, suppliers, and capital providers) externalities are costs of or benefits from the actions of one party that affect the utility or production possibilities of another party F actor-balance equation states that at the costminimizing level of output, the ratios of marginal product to price for each factor are equal factor demand curves display the relation between the quantity of an input the firm demands and its price, holding other factors constant firm is a basic organizational unit of production; for purposes of this book, it is a focal point for a set of contracts firm-specific assets are assets that are significantly more valuable in their current use within the firm than in their next best alternative use outside the firm first-degree price discrimination—see personalized pricing first-mover advantages are the expected benefits derived by the first firm to introduce a product fixed costs are those costs that not vary with output over the time horizon of the analysis formal authority is the power that comes from explicitly assigned decision rights within the organization for-profit organizations have owners (for example, shareholders) who have title to the residual profits of the organization—see nonprofit organization forward integration occurs when the firm begins to conduct additional finishing work or to market its own goods—also called downstream integration www.downloadslide.net Glossary G-5 franchise agreements are contracts between the franchisor (parent) and the franchisee that grant to the franchisee the rights to use the parent’s name, reputation, and business format at a particular location or within a stipulated market area Generally Accepted Accounting Principles (GAAP) are that set of accounting methods commonly used or proscribed by the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) for financial reporting free cash flow problems are incentive conflicts between owners and managers over retaining cash within the firm beyond that necessary to fund value-increasing investment projects; managers prefer to take projects which expand firm size beyond that which maximizes the firm’s value, rather than to distribute the cash to owners goal-based system provides each employee a set of goals for the year and then evaluates employees based on the extent to which the goals are achieved free-rider problems occur in team efforts; each member of the team has an incentive to shirk because each receives the full benefit from shirking, but bears only a part of the costs group incentive pay bases employee compensation on group performance fringe benefits are components of the compensation package other than salary and incentive compensation; they are either in-kind or deferred (such as medical insurance and pensions) full-cost transfer prices use full cost to value goods exchanged between business units; full cost is the sum of fixed and variable cost function refers to a primary activity within the process that a firm employs to provide a product to customers; major functions include research, manufacturing, finance, marketing, sales, and service functional myopia occurs when employees focus on their individual function at the expense of the larger array of activities that must be accomplished to capture as much value as possible given the firm’s business opportunities functional subunits group all jobs performing the same function into the same department G ain from trade is the difference between the minimum value that an owner or a supplier is willing to accept for an item and the maximum price that a prospective buyer is willing to pay game theory is concerned with the general analysis of strategic interaction; it focuses on optimal decision making when all decision makers are presumed to be rational, with each attempting to anticipate the likely actions and reactions of its rivals going private transaction is a term used to describe reorganizations where a publicly traded corporation converts to a closely held corporation group pricing occurs when a firm separates its customers into classes and sets different prices for each class—also called third-degree price discrimination H istorical costs reflect the original purchase price of resources and not necessarily their current opportunity cost; historical costs generally are not relevant for decision making (except for their tax effects) holdup problems can occur when parties invest in specific assets; for example, after the investment is made, the buyer might be able to force a price concession, since it will be in the interests of the seller to continue to operate as long as variable costs are covered horizon problems are the incentive conflicts that can arise between owners and employees due to differential horizons with the firm; employees’ claims on the firm generally are tied to their tenure with the firm, but owners are interested in the present value of the entire stream of future cash flows horse race is a model used by some companies for top management succession A pool of internal candidates compete to replace the CEO The “winner of the contest” becomes the new CEO when the existing CEO retires human asset specificity—see specific human capital and asset specificity human capital is a term that characterizes individuals as having a set of skills that can be “rented” to employers I general knowledge is that which is relatively inexpensive to transfer dentification is a statistical problem that arises in separating the effects of simultaneous equations; for example, separating supply versus demand shifts in explaining the observed changes in market prices and quantities general partnerships are unincorporated businesses with two or more co-owners implementation rights involve the execution of ratified business decisions general human capital consists of training and education that is useful across a wide variety of different firms www.downloadslide.net G-6 Glossary implicit contracts consist of promises and shared understandings that are not expressed by formal legal documents incentive coefficients are weights that the compensation plan places on the various tasks assigned to an employee isoquants display all possible ways to produce the same quantity (iso meaning “the same,” quant from “quantity”) J income elasticity relates the percentage change in the quantity purchased for a good to a given percentage change in income obs define the basic roles and responsibilities of employees; jobs have at least two important dimensions: the variety of tasks that the employee is asked to complete and the decision authority that is granted to the individual to complete the tasks incomplete contracts not specify actions under all possible contingencies joint ventures establish new firms that are owned jointly by two or more independent firms increasing returns to scale for a production function occur when a percent change in all inputs results in a greater than percent change in output just-in-time production (JIT) is a production system whereby each component is produced immediately as needed by the next step in the production process indifference curves display all the combinations of goods that yield the same utility individual proprietorships are unincorporated businesses owned by individuals industry demand curve relates total quantity demanded across all firms in an industry to price of the product inelastic demand occurs when the price elasticity is less than one; in this case, a small increase in price raises total revenue inferior goods are goods for which the quantity purchased declines with income K eiretsu is a form of network organization employed in Japan; it consists of an affiliation of quasi-independent firms with ongoing, fluid relationships; typically, the firms have cross-holdings in each other’s common stock L aw of demand states that normal demand curves slope downward to the right—quantity demanded varies inversely with price influence costs include those nonproductive activities in which employees engage to influence decisions law of diminishing returns states that the marginal product of a variable factor will eventually decline as the use of the factor is increased—also called the law of diminishing marginal product information failures refers to the case where information asymmetries and adverse selection can lead to a breakdown of markets and the failure to consummate potentially beneficial exchanges leadership is the process of persuasion or example by which an individual induces a group to pursue objectives held by the leader; it has at least two important components: establishing goals and motivating others informativeness principle states that it is typically desirable to include in the compensation plan all performance indicators that provide incremental information about the employee’s effort, assuming the measures are available at low cost learning curves display the relation between average cost and cumulative production; learning-curve effects refer to average cost falling as production experience accumulates internal labor markets fill jobs from within the firm In firms that rely primarily on internal labor markets, they are used to fill most non-entry-level jobs; employees typically spend a significant fraction of their careers with the firm leveraged buyout (LBO) is defined as a takeover of a company, financed by borrowed funds (often, the target company’s assets are used as security for the loans acquired to finance the purchase; the acquiring company or group then repays the loans from the target company’s profits or by selling its assets); leveraged buyouts occur at both the corporate and divisional levels (sometimes only part of the firm is sold off); through these buyouts, the companies (or divisions) are converted from publicly traded to closely held corporations investment centers are business units that have all the decision rights of cost centers and profit centers as well as the decision rights over the amount of capital to be invested limited liability refers to organizations (like corporations) in which the owners’ risk associated with the organization is limited to their capital contributions isocost lines display all combinations of the factors of production with the same cost limited liability company is a legal form of organization that is similar to an S corporation; it allows owners to initiation rights are the decision rights to generate proposals for particular business decisions such as resource utilization or contract structure www.downloadslide.net Glossary G-7 obtain the benefits of pass-through tax treatment and limited liability market-based transfer prices use external market prices to value goods exchanged between business units limited liability partnership (LLP) is a legal form of organization available for partnerships consisting of groups of certain types of professionals (such as attorneys, doctors, and accountants); similar to general partnerships except that individual partners are shielded from certain vicarious liabilities market-clearing price is the price at which the quantity supplied of a product is equal to the quantity demanded limited partnership is a partnership in which one or more “general” partners manage the business while “limited” partners contribute capital and share in the profits but take no part in running the business; general partners are personally liable for the partnership’s debts, while limited partners incur no liability with respect to partnership obligations beyond their capital contributions logroll consists of a coalition of individuals who are largely indifferent to one another’s demands, but agree to support a variety of requests so that each can get what he wants long run is the period of time over which the firm has complete flexibility; no inputs are fixed long-run cost curves—see planning curves M form organization—see multidivisional form Malcolm Baldrige National Quality Award was instituted in 1987 by the U.S government to recognize quality achievement by American companies market failures occur because of externalities, public goods, monopolies, and information failures; they keep markets from then providing an efficient allocation of resources market for corporate control is a term used to describe how outsiders can obtain voting control in a publicly traded company through the purchase of shares in the open market; control transactions often are associated with corporate takeovers and mergers market power occurs when a firm faces a downwardsloping demand curve; it can raise prices without losing all sales market structure refers to the basic characteristics of the market environment, including (1) the number and size of buyers, sellers, and potential entrants; (2) the degree of product differentiation; (3) the amount and cost of information about product price and quality; and (4) the conditions for entry and exit markup pricing sets price by estimating its price elasticity and marking up marginal costs; the firm substitutes these estimates into MC*͞[1 Ϫ 1͞*] marginal benefits are the incremental benefits associated with making a decision matrix organizations are those that are characterized by intersecting lines of authority; they have functional departments (such as finance, manufacturing, and development), but employees from these functional departments also are assigned to subunits organized around product, geography, or some special project—individuals report to both a functional manager and a product manager See function and functional subunits marginal cost (MC) is the change in total costs associated with a one-unit change in output—marginal costs can be defined for either the long run or the short run meeting-the-competition clause is a contractual provision that guarantees that the seller will match the price offered by a competitor marginal-cost transfer prices use marginal production cost to value goods exchanged between business units menu plans—see cafeteria-style benefit plans marginal analysis considers only the incremental costs and benefits in making a decision; costs and benefits that not vary with the decision are sunk and hence are irrelevant marginal product (MP) of an input is the change in total output associated with a one-unit change in the input, holding other inputs fixed marginal revenue (MR) is the change in total revenue given a one-unit change in quantity marginal revenue product (MRP) is the incremental revenue that the firm obtains from employing one more unit of the input (the incremental output times the incremental revenue)—also called the value of the marginal product market consists of all firms and individuals who are willing and able to buy or sell a particular product menu pricing involves offering all potential customers the same menu of purchase options Customers self-select among the alternatives, thus revealing information about their demand elasticities—also called second-degree price discrimination minimum efficient scale is the plant size at which longrun average cost first reaches its minimum monitoring rights represent the opportunity to oversee whether the obligations of another party have been met monopolistic competition is a market structure that is a hybrid between competitive markets and monopoly; firms have downward-sloping demand curves for their www.downloadslide.net G-8 Glossary differentiated products, but economic profits are limited by entry and competition (examples include the markets for toothpaste and golf balls) receive significant tax breaks; only organizations with a social purpose can organize as nonprofits—see for-profit organizations monopoly is a market structure where there is only one firm in the industry; here, industry and firm demand curves are the same normal goods are those for which the quantity purchased increases with income moral-hazard problems—see postcontractual information problems O most-favored-nation clause is a contractual provision that guarantees the seller will not sell to another buyer at a lower price motion studies are the systematic analysis of work methods considering the use of raw materials, the design of the product or process, the order of work, the tools, and the activities at each step multicollinearity is a statistical problem that arises when the factors that affect a dependent variable in a regression are highly correlated (tend to move together); it can make it difficult to estimate the individual effects of the explanatory variables with much precision multidivisional form of firm organization groups jobs into a collection of business units based on factors such as product or geographic area; operating decisions such as product offerings and pricing are decentralized to the business unit; and each business unit has its own functional subunits—also called M form organization multitask principal-agent model examines the incentive problems that arise when an employee is assigned multiple tasks N ash equilibrium occurs when each firm is doing the best it can, given the actions of its rivals negotiated transfer prices use prices set by negotiation between the two business units to value goods exchanged between them bjective performance measure is a measure that is easily observable and quantifiable oligopolistic market is a market structure that has only a few firms which account for most of the production in the market; products may or may not be differentiated; firms can earn economic profits omitted variables problem is a statistical problem that arises from estimating equations without all the relevant explanatory variables operating cost curves are used in making near-term production and pricing decisions—also called short-run cost curves opportunity cost is the value of the resource in its next best alternative use organizational architecture comprises the three critical aspects of corporate organization: (1) the assignment of decision rights within the company, (2) the methods of rewarding individuals, and (3) the structure of systems to evaluate the performance of both individuals and business units outside directors are commonly defined as board members who are not existing managers or their family members The stock exchanges have more stringent definitions of outside or independent directors outsourcing is moving an activity outside the firm that formerly was done within the firm; it can also refer to an outgoing arrangement for using external firms either to supply inputs or distribute products network effects occur where the demand for a product increases with the number of users (for example, fax machines are more useful the more people use them) P network organizations are those that are organized into work groups based on function, geography, or some other dimension; the relationships among these work groups are determined by the demands of specific projects and work activities, rather than by formal lines of authority; these relationships are fluid and frequently change with changes in the business environment passing-the-baton is a prominent model used by companies for top management succession An heir apparent to the CEO is identified and given a title such as president or COO Contingent on firm and individual performance, the heir apparent eventually becomes the new CEO nonprofit organization is a legal form of organization in which persons who control the organization are forbidden from receiving the residual profits; these organizations areto efficiency occurs when there is no feasible alternative that keeps all individuals at least as well off but makes at least one person better off pass-through organization is one in which the income of the organization is passed through to the owners’ tax returns and is taxed only at the personal level www.downloadslide.net Glossary performance evaluation is the process of appraising the correspondence between employee productivity and employer expectations personalized pricing occurs when the producer extracts all potential consumer surplus from each potential consumer— also called first-degree price discrimination physical asset specificity—see asset specificity planning curves play a key role in longer-run planning decisions relating to plant size and equipment acquisition— also called long-run cost curves postcontractual information problems are agency problems that occur because of asymmetric information after the contract is negotiated; individuals have incentives to deviate from the contract and take self-interested actions because the other party has insufficient information to know whether the contract was honored—also called moral-hazard problems potential entrants are all firms that pose a sufficiently credible threat of market entry to affect the pricing and output decisions of incumbent firms precontractual information problems are contracting problems that occur because of asymmetric information at the time the contract is being negotiated; these problems include adverse selection and bargaining failures preferred stock is a type of stock whose holders are given priority of common stockholders in receiving dividends The dividend is typically fixed at the time of issue price discrimination occurs whenever a firm’s prices in different markets are not related to differentials in production and distribution costs; it involves charging different consumers different prices based on their elasticities of demand price elasticity of demand—see elasticity of demand principal-agent model examines incentive problems among contracting parties, especially within organizations prisoners’ dilemma is a game-theory model that examines the tension between group interest and individual selfinterest; the equilibrium is for the two prisoners to confess, even though it is in their joint interest not to confess product attributes are the various characteristics of a product that buyers value product life cycle is the pattern in the demand for products over their life cycles; it is divided into four stages: introduction, growth, maturity, and decline Typically, the demand for a successful product increases rapidly through the growth phase; the demand tends to level off during the maturity phase; it eventually drops when the product enters the decline phase G-9 production function specifies the maximum feasible output that can be produced for given quantities of inputs profit centers are business units whose managers are given decision rights for input mix, product mix, and selling prices (or output quantities) and are asked to maximize profits given a fixed capital budget profit-maximizing level of production occurs when marginal revenue equals marginal cost property right is an enforceable right to select the uses of a good proxy statement refers to a document, which the SEC requires a company to send to its shareholders, that provides material facts concerning matters on which the shareholders will vote Public Companies Accounting and Oversight Board (PCAOB) oversees public accountants’ audits of publicly traded corporations Created by the Sarbanes-Oxley Act of 2002 public goods are those commodities whose consumption by one person does not diminish the amount available to others publicly traded corporations are characterized by stock that is sold to and traded among the general public (often on organized exchanges, such as the New York Stock Exchange) Q uality can refer to high mean, low variance, more options, or meeting customer expectations quality circles are voluntary work groups that meet regularly to discuss how to improve the quality of products and work processes R atchet effect refers to basing next year’s performance standard on this year’s actual performance; such standard setting can induce employees to restrict production in the current period in order to limit the increase in their future performance benchmarks ratification rights are those that involve the choice of the business-decision initiatives to be implemented reaction curve displays one firm’s optimal choice (of output, for instance), given the choice of another firm reengineering is a management technique defined as the fundamental rethinking and radical redesign of business processes to achieve improvements in measures of performance, such as cost, quality, service, and speed relative-performance evaluation measures employees’ performance relative to peers www.downloadslide.net G-10 Glossary relative price is the price of one good as compared to another repeated relationship occurs when two parties expect to interact with each other over time; sometimes it is possible for the parties to cooperate in a repeated relationship, even though they would not cooperate in a one-time interaction due to incentive conflicts Sarbanes-Oxley Act of 2002 (SOX) is an important U.S law relating to corporate governance and financial disclosure adopted in the aftermath of the 2001–2002 corporate governance scandals second-degree price discrimination—see menu pricing reservation price is the maximum price that the buyer is willing to pay, or the minimum that the seller is willing to accept Securities and Exchange Commission (SEC) is the primary federal regulatory agency for the securities industry The SEC’s mandate is to promote full and accurate disclosure and to protect investors against fraudulent and manipulative practices in the securities markets reservation utility is the utility that the employee can obtain in the next best alternative; the employee must be paid her reservation utility or she will not work for the firm self-selection occurs when people with differential private information identify themselves to outsiders by choosing contracts that best fit with their private information residual claimants have the legal rights to the profits of the enterprise once the fixed claimants of the firm (for example, bondholders and employees) are paid shareholder proposals are voting proposals that are initiated by shareholders and often not supported by management They are included in the proxy statements sent to shareholders In the United States, boards of directors not have to adopt shareholder proposals even if they receive a majority of affirmative votes residual income measures business-unit performance by subtracting a stated return on investment from division profits residual loss is the dollar equivalent of the remaining loss in value that results because incentive problems have not been completely resolved by out-of-pocket expenditures on monitoring and bonding residual use rights for an asset are the rights to select any use that does not conflict with prior contract, custom, or law return on assets (ROA) is the ratio of accounting net income generated divided by total assets; ROA is a commonly used investment-center performance measure returns to a factor define the relation between output and the variation in only one input, holding other inputs fixed returns to scale is the relation between output and a proportional variation of all inputs taken together revenue centers are business units that evaluate performance based on revenue generation risk-averse individuals prefer a lower level of risk, holding the expected payoff fixed risk-neutral individuals care only about expected value and are indifferent to the level of risk risk premium is the difference between the expected value of a risky income stream and its certainty equivalent S corporations were created in 1958 as part of a tax program to help small business; limits on the number and type of shareholders make this organizational form unattractive to most large firms; income is passed through to the owners’ tax returns; shareholders have limited liability—see C corporations short run is the operating period during which at least one input (frequently capital) is fixed in supply short-run cost curves—see operating cost curves short-run profit maximization occurs when marginal revenue equals short-run marginal cost shortage occurs when the price in the market is lower than the market-clearing price and quantity demanded is greater than quantity supplied; as inventories are depleted, suppliers have incentives to raise prices shut-down condition in the short run occurs when price is lower than average variable cost; in the long run it occurs when price is lower than long-run average cost site specificity occurs when an asset is located in a particular place that makes it useful only to a small number of buyers or suppliers and it cannot be moved easily—see also asset specificity specialized task assignments are those in which individual employees concentrate on a limited set of tasks—see broad task assignment specific assets are those that are worth more in their current use than in alternative uses specific human capital is created by learning things that are expected to be useful only within a specific contractual relationship—see asset specificity specific knowledge is that which is relatively expensive to transfer spot market is one in which the exchange is made immediately at the current market price with no long-term commitment between the buyer and the seller www.downloadslide.net Glossary stakeholders describe various parties affected by a corporation’s actions, such as shareholders, employees, and the broader community standard rating scales require the performance evaluator to rank the employee on a number of different performance factors using a scale (for example, far exceeds requirements, exceeds requirements, meets all requirements, partially meets requirements, does not meet requirements) strategic alliances are any of a variety of agreements between independent firms to cooperate in the development and/or marketing of products strategy refers to the general policies that managers adopt to generate profits; rather than focus on operation detail, a firm’s strategy addresses broad, long-term issues facing the firm subjective performance evaluation is an evaluation that is based on the personal opinion of the supervisor rather than on some objective measure (such as the quantity of output) substitutes are goods that compete with each other; if the price of one good is increased, the consumer will tend to shift purchases to the other good substitution effect in producing a product occurs when the firm shifts among inputs due to changes in their relative prices sunk costs are those nonrecoverable costs that have already been incurred and the resources have no alternative use supply curve displays the quantity producers are willing to sell at each price; the curve typically slopes upward—at higher prices producers are able and willing to produce and sell more units surplus occurs when the price in the market is higher than the market-clearing price and quantity supplied is greater than quantity demanded; as inventories build, suppliers have incentives to reduce prices survival of the fittest is a principle implied by the concept of economic Darwinism; companies have the greatest chance of survival if they are organized efficiently given their particular environment T eam production occurs when interdependencies among employees and assets cause the value of the inputs as a team to be greater than their opportunity costs telecommuting occurs when employees work out of their homes and communicate with the central office via fax, computer, or telephone third-degree price discrimination—see group pricing three legs of the stool is an analogy used to characterize organizational architecture; like a balanced stool, a G-11 well-designed organization should have an architecture in which the three components (the assignment of decision rights, the reward system, and the performance-evaluation system) are coordinated time studies are a wide variety of techniques employed for determining the duration a particular activity requires under certain standard conditions total cost curve (TC) displays the relation between total costs (total fixed costs plus total variable costs) and output total product (TP) of an input is the schedule of output obtained as the input increases, holding other inputs fixed total quality management (TQM) includes those management processes and organizational changes necessary to meet customer expectations and to achieve continual improvement total revenue is the product of price times quantity sold transaction costs—see contracting costs (note that this term frequently is used to refer only to out-of-pocket contracting costs) transfer price is the amount one business unit pays another for goods and services that are exchanged between them two-part tariff is a pricing mechanism in which the customer pays an up-front fee for the right to buy the product and then pays additional fees for each unit of the product consumed; two-part pricing is sometimes used in contracts between manufacturers and distributors two-tier board is a board structure used in countries following the German model The supervisory board consists of large shareholders (including banks, corporations, and insurance companies) and employee representatives Employee representatives have 50 percent of the board seats The supervisory board selects a management board that has primary operational authority U form organization—see unitary organization unitary elasticity of demand occurs when the price elasticity is equal to one; a small increase in price is associated with no change in total revenue unitary organization groups jobs by function (engineering, design, sales, finance, and so on); it places each primary function in one major subunit (rather than in multiple subunits)—also called U form organization unlimited liability refers to organizations (like general partnerships) in which the owners face unlimited personal liability for debt and other claims against the organization www.downloadslide.net G-12 Glossary upstream integration—see backward integration utility is an index of personal well-being utility function is the relation between an individual’s well-being (utility) and the level of goods consumed V alue of the marginal product (VMP)—see marginal revenue product variable costs are costs which change with the level of output vertical chain of production is the series of steps in the production process vertically integrated firms are those which participate in more than one successive stage in the vertical chain of production vision refers to a course of action for the firm—see also corporate strategy W ork sampling is one type of time study that involves selecting a large number of observations taken at random intervals and observing how long employees take in performing various components of the job www.downloadslide.net ... First Edition MANAGERIAL ECONOMICS Baye and Prince Managerial Economics and Business Strategy Eighth Edition Brickley, Smith, and Zimmerman Managerial Economics and Organizational Architecture. .. CHAPTER OUTLINE Managerial Economics and Organizational Architecture Organizational Architecture Introduction LEARNING OBJECTIVES Define organizational architecture and discuss how economics can.. .Managerial Economics and Organizational Architecture The McGraw-Hill Series in Economics ESSENTIALS OF ECONOMICS ECONOMICS OF SOCIAL ISSUES MONEY AND BANKING Brue, McConnell, and Flynn