Dirección comercial I - Tema 4 PDF

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Apuntes de dirección comercial I del tema 4...

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1. Labor relations and teams A team is a collective of individuals gathered to achieve a specific group objective. ● Complementarity ฀ The effort/skill of one person is more valuable when combined with the effort/skill of another person. ● Working together leads to a higher productivity than the sum of the productivity of people working as individuals (specialization). Examples: Song collaborations (“featuring”), Barça, La Casa de Papel.

GOOD AND BAD TEAMS Some groups work well, while others do not: ฀ Good teams ฀ Linux and Android developers. ฀ Bad teams ฀ Failed start-ups: Ferrari F1. What makes a team good or bad depends on a set of key problems: we need incentives to exert effort.

MORAL HAZARD IN TEAMS Recall that workers may take opportunistic actions. Consequently, managers must implement solutions like monitoring, pay for performance or bonding costs.

PAY FOR PERFORMANCE SOLUTION It may not be the best solution to be applied to teams, as measuring individual output is difficult because of the dependence of team output on all the individual members’ inputs. Examples: Percentage of Barça’s victories attributable to Messi individually, percentage of BLACKPINK revenues attributable to Lisa individually. Therefore, we could base individual pay on team performance, but this can create another problem by generating externalities: o Positive externality ฀ If they increase their own payoff and also the others’ payoff.

o Suboptimal effort ฀ If they do not care about the others’ payoffs and benefit from the contributions of others without contributing oneself. This is called free-riding.

SOLUTIONS FOR THOSE EMPLOYED AS INDIVIDUALS MONITORING: Control options Variables to consider: Group size, difficulty to monitor performance, group members’ preferences, likelihood of repeated interaction, difficulty to fire workers. ● No control ฀ No monitor or reward performance at all. Example: Wikipedia. +: Motivation (trust) and flexibility for employees, eliminates layers of middle management that can create bottlenecks, promotes innovation (ideas can come from anyone in the organization). -: Tasks can take longer, harder to detect poor performance, opportunistic behaviour.

● Non-specialized control ฀ The group monitors itself. Individual members work and monitor at the same time. 1. Mutual control: Everybody monitors everyone at the same time. ฀ Social disapproval: Some people claim that in the past, shame was a primary source of good behaviour. Therefore, the threat of loss of reputation may align individual behaviour with the group’s best interest. Example: In microfinance, “if one of you fail to repay the loan, none of you will receive more money”. Those who cannot repay the loan will face social disapproval. This is an incentive for them to get the money. 2. Control by turns: One person monitors everyone else for a fixed time and gets replaced. Example: Rotating presidency of the European Union. ฀ Problem: The person monitoring needs to learn how to do it. Not enough time to stablish their own processes. Lack of specialization ฀ Non-specialist control requires workers to perform two roles:

1) Production

●

Specialized control artist manager.

2) Monitoring

฀ An external party monitors the group. Example: Music

The specialized monitor’s job is to: ✔ Observe and evaluate individuals’ performance ✔ Reward them according to their team contribution (explicit pay or promotions). a

The control options are not fully mutually exclusive. Monitoring will improve team profits but will also incur costs.

RESIDUAL CLAIMANT The monitors can be residual claimants ฀ They must pay all the costs themselves, but also get to keep the team’s output (they bear all the costs but also keep all the profits). If the monitors are the residuals claimants, they have more efficient incentives to invest.

ORGANIZATIONAL SOLUTIONS Separating ownership from production can be efficient. An optimal organization can feature a team of people involved in production, overseen by a monitor who is a residual claimant.

Capitalist firms are the most optimal organizations, as ownership makes the entrepreneur a residual claimant. The owner pays all the costs of running the firm but takes all the profit.

2. Incentive compensation and risks THE BASIC INCENTIVE PROBLEM BASIC PRINCIPAL-AGENT MODEL

Owners (or employers) and employees have different objectives. o The owner (principal) wants maximum profit and maximum employee effort. o The employee (agent) wants maximum utility (work slower, rest more, etc.).

DESIGNING A SALES CONTRACT Performance (output) ฀ Volume of sales (V). It depends on a level of effort (e) and receives compensation (salary, S). Salesman’s utility function ฀ 𝑈(𝑆, 𝐸) = 𝑆 − 𝑒 ● Risk aversion: Utility increases with salary, but in a diminishing way (marginal utility is positive but decreasing). ● Effort aversion: U decreases with effort. ✔ Risk-loving agent: Convex utility function. ✔ Risk-neutral: Linear utility function. ✔ Risk-averse: Concave utility function. The principal’s maximum monetary profit is B(V,S,CF) = 0,20V – S – 10 ฀ In this case, he/she receives 20% of sales, pays salary (S) and there’s 10 units of fixed cost. Suppose that sales have the following probabilities distribution:

As probability increases with effort, we can say sales are informative of effort. However, V does not exactly correspond with e.

Reservation utility: Utility that the employee can obtain in the next best alternative. The employee must be paid at least this reservation utility, or they will not work for the firm.

EXAMPLE: Find the reservation utility of a salesman whose best alternative consists of a fixed salary (S) of 4 and a required effort in monetary units of 1. 𝑈(𝑆 = 4, 𝑒 = 1) = 4 − 1 = 2 − 1 = 1

OBSERVABLE EFFORT. One can contract directly in terms of effort. Then, the salary is set at the level that offers the reservation utility to exert the chosen level of effort.

EXERCISE: What salary should we pay a worker in the following conditions? And which option is best for the employer? ฀ The reservation utility of the worker is 1. ฀ The principal keeps 20% of the expected output and the fixed cost is 10. ฀ For the sales, use the probabilities distribution of the last page. 1. Option 1 (high effort): I want him to exert an effort of 2. Salesman utility function: Principal’s maximum monetary profit:

2. Option 2 (low effort): I want him to exert an effort of 1. Salesman

utility

Principal’s maximum monetary profit:

function:

Answer: The principal prefers to hiring the worker with a high effort, because the principal gets a higher monetary profit. Therefore, we must pay him a salary of 9. Pareto efficiency ฀ The high effort option improves the principal’s outcome without making the agent worse off.

UNOBSERVABLE EFFORT The agent’s effort is not observable, but performance (output) is observable. In order to align both the principal and the agent’s interests and avoid opportunistic behaviours, we can use contracts that describe the relationship. These contracts are designed in a way that salary depends on results.

Problem of the performance pay incentive method

฀ However, some factors that

can influence performance are random: they do not depend neither the employees nor the employers. Example: In times of economic crisis, performance decreases. Therefore, if compensation depends on profit and profit does not depend only on effort, the agent assumes more risk. ● Agent ฀ Risk-averse: Prefers less dispersion of the results for the same expected rent. ● Principal ฀ Risk-neutral or less risk-adverse than the agent: Shareholders usually have a diversified portfolio, so they are less worried with the outcome of one of their many businesses.

There is asymmetric information ฀ Moral hazard: The salesman can promise high effort (in exchange of a high salary), but once contract is signed, exert low effort and blame worse outcome on bad luck.

EXERCISE: Formalize a contract to motivate high effort (e=2). Pay salesman a salary of S100 OR S200, as a function of sales being 100 or 200. ฀ The principal keeps 20% of the expected output and the fixed cost is 10. ฀ For the sales, use the probabilities distribution of two pages before.

Principal’s objective function:

Every optimal contract has to satisfy two conditions: 1. Participation ฀ The agent must be willing to accept the contract.

2. Incentive compatibility ฀ The actions the principal expects the agent to take must be compatible with the incentives spelled out in the contract.

or, graphically:

Optimal contract in this case: The principal pays 2,25€ when sales are low (S100) and 12,25€ when sales are high (S200).

The salesman is indifferent (has the same utility) between: ● Exerting (e=2):

high

effort

● Exerting low effort (e=1):

OPTIMAL RISK-SHARING The profit for the principal is:

So, for e=2:

Why is the profit (B) smaller, and the salary (S) higher when effort is unobservable? Because the salesman needs to be compensated for the additional risk-taking. This is done via a bonus of 0,75 (comes from 9,75-9). For the salesman, the gross utility of receiving a variable salary is equal to the one for receiving a fixed salary of 9:

Extra compensation for the risk taken (risk premium) generates a cost due to inefficient risk allocation. ✔ Agent’s situation does not improve (same utility). ✔ Principal’s situation gets worse (less B).

EFFECTIVE RISK-INCENTIVE ALLOCATION The trade-off in designing a contract is between risk-sharing and incentives.

Efficient risk-sharing suggests that it is better to pay employees fixed salaries, while incentive considerations suggest that is better to tie pay to performance. 1. From the point of view of principals, it is better to pay a fixed salary to employees and leave total risk to the shareholders. Then, the firm avoids paying a premium for risk taking to attract employees. However, if the principal does not insure the agent against output uncertainty, high levels of risk may lead a risk-averse agent to reject the contract. 2. On the other hand, incentive-based contracting motivates employees, suggesting that linking salary to result is good. Incentive-based contracting is favoured by the level of employee risk aversion, the level of risk not controlled by the employee, the employee’s response to incentives and the cost of assessing employee performance (the more expensive is to measure output, the less efficient is to offer incentive pay)....