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Category: Organizational Behavior

  • Job design – Span of Control and Span of Accountability considerations

    In the last blog, we began looking at how to design a good job and discussed the 4 questions to be answered. In today’s blog we look at two of these 4 factors – span of control and span of accountability. 
    Span of control refers to the range of resources (people and infrastructure) that are given to the manager to decide upon. Since the manager is responsible for controlling he/she is also responsible for the performance of these resources. Managers would have to adjust the span of control for each position on the basis of how the company delivers value to its customers – it has to align with the company’s focus. This span could be “wide” or “narrow”.
    The Span of Accountability reflects the trade-offs that affect the measures used to evaluate a manager’s achievement. The setting for this span allows us to determine the behavior we intend to see. 
    The span of control and span of accountability are interrelated, and make the most sense when considered together. Span of Control defines the resources available for the manager, while the span of accountability defines the goals that manager should focus towards. This is in synch with the common knowledge – “Authority should match responsibility”
    We shall look at the other two spans of in the next blog.

  • Designing a good job


    In the last blog we concluded with the last of the mechanisms to control the issues of agency costs. In this blog we begin a new discussion on the design of jobs – the discussion that follows over the next few blogs is based on the HBR article – Designing High performance jobs by Robert Simons.

    A common situation that an entrepreneur gets into is that after having begun with an exciting vision and building a good strategy and developing a strong product, hired good people to build the necessary networks but then implementation goes bad! A lack luster response is seen from the managers, delays in delivery to customers are common, and there are several coordination issues. The entrepreneur begins to ask – “have I chosen the wrong people in these critical jobs?” A closer look and the problem look to be at all levels and across the organization.

    These issues are generally because the balance of what an employee expectation of organization’s resource in supply are not balanced by the demand that the individual in that role has for the organizational resources. The balance is essential and requires answers to the four basic questions

    1. What resources do I control to accomplish my tasks?
    2. What measures will be used to evaluate my performance
    3. What do I need to interact with and include achieving my goals?
    4. How much support can I expect when I reach out to others for help?

    Put other way these are questions about

    1. Control
    2. Accountability
    3. Influence
    4. Support

    We shall continue discussion on these over the next few blogs

  • The role of market discipline in agency theory

    In the last blog we looked at bonding and incentives as a mechanism to handle agency costs. In today’s blog we look at the role markets play in determining the arrangements and outcomes that agency theory predicts.
    Agency theory adopts a semi-strong form of capital market efficiency. We mentioned this to be semi-strong since the asset prices do not reflect all the information – irrespective of public or private. We also cannot call it weak since the info of prices doesn’t limit itself to historically available information. 
    One of the implications of this semi strong assumption is as follows – if managers (agents) of the firm  take actions that are viewed adversely affecting the value of the firm’s assets, then the price of these (stock price) will drop. If the situation progresses this way, the firm’s management could eventually lose control of the firm – the old high agency cost managers will be replaced by low-agency cost managers. This is akin to take over. If by the takeover, significant wealth gains are achieved – in many ways this could be associated with the reduction in the agency cost that is expected after the acquisition is complete.  
    In many cases economics is slow to recognize conflicts within firms and between the firms and its numerous stakeholders, the influence of agency theory in organization economics could hardly be neglected.

  • Bonding as a mechanism to reduce Agency costs

    In the last blog we looked at the monitoring mechanisms that are used to reduce the agency costs. In today’s blog we look at Bonding and Incentives as a mechanism to reduce the agency costs.
    To understand this mechanism of reducing agency costs – it is important to realize that it’s not just the principal who has gains by reducing the agency costs, the agent too would benefit from this. Incentives are the most common of the bonding mechanisms that agents use to bond closer to the principal. Generally, the agent aligns the incentives such that their self-interest is aligned so that they behave consistent with the interest of the principals. 
    The most common of these is the agent’s compensation package. The Principals would prefer an incentive that fully penalizes agents for shirking and opportunism; however in many cases it is the environmental risks that really define the outcome. Thus the agents wouldn’t be comfortable with this structure. The fixed salary format in fact would free the agent from any of the alignment possible with the principal and might not find the buying in easy from the principals.
    Research has found that, managers with significant ownership interest in their firms are less likely to engage in behaving in ways that are not in synch with the principal’s interest. Last but not the least it is important to look at incentive structure not just limited to payments as incentive – promotions too are an important factor.

  • Monitoring to reduce agency costs

    In the last blog we looked at the rationale for organizations to delegate. In the current blog we look at the report to monitoring that organizations adopt and the various aspects involved there in.
    Monitoring the agents is important given it is extremely important to reduce the agency costs for the principals. Broadly there are 3 varieties of monitoring, which we shall discuss here.
    In this direction, the principals would be extremely happy if they could access complete information of the agent’s behavior and if these are in synch with the principal’s choices it would be of the best interest. However this logic would be flawed if we consider the case of a scientist or top management who could immersed in thinking activity staring outside the window! The principal in such a scenario will not in any way be able to assess if this behavior is in the best interest or not thus, any mechanisms of using monitoring costs could only imperfectly reduce agency costs.
    An alternate to monitoring the agent behavior is monitoring the outcome of the agent behavior. This approach too is not without issues – it works efficiently when the tasks are not highly programmable, but gets problematic when team production is involved. Interdependence between agents makes it harder to quantify the contribution to the output.
    The third mechanism used to monitor is the use of independent directors on corporate boards. The rationale is that the independent director would be able to provide objective assessment of the decisions that board would take and contribute to reducing the agent behavior.
    Through all these mechanism the attempt is to align the interests of the principal and the agent, however achieving this 100 % is extremely difficult given that delegation always creates agency costs.

  • Why do organizations delegate?

    In the last blog we looked at the costs associated with agency problem. In today’s blog we look at some of the basic questions which come to mind given the costs discussed and then discuss about the reason why delegation happens.
    The three questions which come to mind given the costs a principal incurs to address the agency problem are
    1. Why do Principals delegate authority to agents when the problems are costly to monitor?
    2. What are the specific monitoring mechanisms that principals adopt?
    3. What are the specific bonding mechanisms that agents use?

    In reality we find two broad classes of organization – small ones and larger ones. Smaller ones are generally proprietary or partnership firms or closed corporations which operate on a small scale. The range of economic activities involved in these is all managed by the single person or the people associated effectively. There is no delegation and hence no associated agency cost. 

    In the larger organization, the simplicity of the smaller organizations is lost. The single individual is unable to engage in all the business activities given the constraints of time, energy and the bounded rationality of the person. Hence, the delegation is a necessity in these organizations, along with this comes the agency cost.
    The solution to this problem of delegation in large organization is way we could look at the decision making process (Fama and Jensen – 1983), as having 2 components 
    • Decision Management – how a decision is initiated and how it is implemented
    • Decision Control – how a decision is ratified and monitored

    This distinction allows management group to focus on its task while the control group focuses on its. It has been shown to be lead to higher-quality decisions. Stated differently, when decision making situation is likely to overwhelm the cognitive capacity of a single individual, assigning different groups to different parts of the decision making process is likely to improve the decision quality. But this also implies the associated agency costs.

  • Cost associated with taming the Agency Costs

    In the last blog, we began our discussion about Agency theory and its origin. In today’s blog we look at the costs associated with the prevention, and how these are resolved.
    The costs incurred to reduce the possibility of agents misbehaving are called Agency Cost. These include the monitoring expenditure by principals, bonding expenditure by agents and the residual loss of the principal. There is a strong incenting to reduce these costs – for both principals and agents. The common interest is in defining a monitoring and incentive structure that produces outcomes as close as possible to being a costless information exchange.
    Two sources for the agency problem are:
    Moral Hazards – involves situations where much of the agent’s actions is hidden from the principal or is costly to observe. Stockholders finding it difficult to monitor the behavior of their top management team.
    Adverse Selection – the agent possesses information that the principal doesn’t observe or it is very costly to obtain. This prevents the principal from fully ascertaining whether or not their interests are fully served to the best by the agent’s decision.
    These agency problems are generally resolved through monitoring and bonding. Monitoring involves observing the behavior and/or performance of agents. Bonding refers to the arrangement which penalizes agents for acting in ways that violate the interests of principals or reward them for achieving principal’s goals. Generally these are done through contracts.

  • What is Agency Problem in businesses?

    In the last blog, we looked at some of the issues that happen within the organization, but are not explained by the TCT. In today’s blog we build on this drawback and begin our discussion on “Agency Theory”. 
    Agency Theory has its origin from the property rights literature and to a very small portion on the TCT. Just like TCT, Agency theory also assumes that humans have bounded rationality, are self interested and are prone to opportunism. Both theories emphasize on information asymmetry problems in contracting and on efficiency as the engine that drives the transaction governance. The two differ in that; Agency theory emphasizes the risk attitude of principals and agents.
    When Agency theory originated, the emphasis was on the relation between managers and stockholders. It analyzed the corporate governance issues including – the role of directors, role of top management compensation. This has been extended to explain a numerous intra-organizational conflicts.
    For the sake of clarity – an agency relationship occurs when one partner (the principal) in a transaction delegates authority to another (The agent) and the welfare of the principal is affected by what choices the agent makes. The most common example we see is the relationship of investors in a firm and the mangers of the firm. 
    In the case explained above, the investor delegates the management authority to managers who may or may not have any equity ownership in the firm. The problems that could arise are:

    1. The interest of the two parties diverge
    2. Agent actions cannot be seamlessly and costlessly be monitored
    3. Information available to the principal is not the same as the information available to the agent

    These three together form the agency problem

  • Does TCT really look at what happens within the organization


    In the last blog we looked at the criticism on the Transaction Cost Theory. In today’s blog we focus on a specific drawback in the TCT which has enabled the evolution of different line of thought.

    If we carefully look at TCT we realize that underlying all the discussion is that the organization under consideration is always thought to have a single objective towards which it functions. In reality this is really not the situation, in organizations there is always a possibility of conflicts arising. These goals are generally due to conflicting goals of those associated with the firm. The TCT believes that maximizing profit is the goal, however in reality – these goals within a firm are emerging and change over time and also shifts among organization members.

    TCT though explains why organizations exist, fails when it comes to explaining how those associated with the firm agree on the goals set out to achieve. Just because, the economic exchange partners find it in their mutual self-interest to form an organization doesn’t mean that the differences in interests, tastes, and performances cease.

    This sort of indicated the early departure from the neo-classical firm theories of which TCT was the primary one. Continuing from this blog we look at some theories which tackle this specific challenge of to the theory.

  • Criticism to the Transaction Cost Theory

    In the last blog we looked at TCT being applied to hybrid organizations. In today’s blog we discuss about the criticism to the Theory.
    All is not perfect with any theory, and TCT is no exception. There are 3 major criticisms to the theory
    1. It focuses on Cost Minimization 
    2. It understates the cost of organizing
    3. It neglects the role of social relationship in economic transactions

    There are a set of theories classified under – Resource based theories, which emphasize that organizations would have to make and exploit transaction specific investment under conditions of uncertainty to gain long term competitive advantage. Minimization of transaction cost would have little advantage if transaction specific assets aren’t valued in the market. Hence, it is important to move beyond the perspective that “economy is the best strategy” for an organization.
    When we attempt to do a certain transaction in house, there is no guarantee that this would reduce the negotiations and haggling associated with the transaction. In reality, there is a higher possibility of costly bargaining and influential behavior. Even the authority to resolve such issued could behave opportunistically. Given this situation, TCT underestimates the costs associated with the organizing the transaction within the firm.
    In real life, many transactions are influenced by the expectations that are formed by the history of the relationship between the parties. This indicated that transactions are embedded in the networks of social relationship. It is these relationships that explain the situations like trade between close friends without the presence of any contracts, commitments etc. The TCT neglects the role of social relationships in transactions. 
    TCT is still an evolving field and it is important to note that the criticisms are definitely been evaluated for improvements.