Econ class notes - Al Slivinski PDF

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Al Slivinski...

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Class 2 

Types of Organizations o Ex. UWO, GM Canada, Catholic Church, London Mission Services, Canada Post, LCBO o It's pretty clear what it means to own my watch, it's also true that as the owner if it breaks the ownness is on me to spend whatever required to repair/maintenance. I could give it away, or sell it. There are rules, legal restrictions of ownerships, but within the bounds I can do what I want.  Two aspects of owning my watch- do what I want (physical control), and financial (fixing issues, sell)  Suppose I can separate these two aspects. We write a legal contract and say Al gets the first part (wear it, put it etc.), and Ben gets the second part (if it happens to break down, or sell it, he pays/gets the money). Seems like a bad deal for Ben. o Owning orgs is more complicated.

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Two dimensions (differences in) o Ownership  Control Rights (CR)  correspond to you can do what you want. Decide what happens  Residual Claimant Rights (RCR)  correspond to the financial. If there are any net revenues, we have a right to it, but are also the liability for net losses o Motivation, or objectives

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3 Types of Orgs (+ sub-types)

o SOE (crown corps)  Ex. Canada Post (federal)  Who has the CR? Interested in the high-level stuff (who sets direction) They have a CEO, who has CR but they are limited (he doesn’t make every decision, he delegates. He can also get fired).  Who has RCR? Taxpayers (the subsidy comes from the taxes we pay). If they ever make money (usually s loss), the federal government would then spend it on stuff for us (ex. Like LCBO’s profits). o NP  CR? CEO  RCR? Nobody (by definition they should not have residual revenues, but it's more complicated). Non-distribution constant- some aspect of your charter says if we get positive net revenues, it cannot get distributed, you can put it in the bank, augment services, but you can't have any set of individuals as an aspect of the org to have a claim on it. It works the other way, that no one is liable for losses o FP (commercial)  Sole-proprietorship  One person has CR (with employees there is some diffusion of CR) and RCR  Partnership  CR (could make them shared, but often one person is the managing partner for day-to-day, with bigger decisions shared) + RCR (have to decide how they are going to be divided, 50/50?)  Corporation (limited liability- shareholders are not liable for losses)

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 Private corps (May be shares, but they are privately held (cannot be traded on public exchange)) o CR? CEO, or someone in charge o RCR? Shareholders (almost certainly overlapping group of people for both CR and RCR. Lower chance of conflict)  Public corps (IPO – initial public offering for shares) o CR? CEO, or someone high level o RCR? Shareholders (separate from CR, basically none in terms of CEO. Chance for conflict). However saying you have the right to net revenues is misleading, on the surface there seems to be unavoidable conflict )separation of ownership and control) o Ex. UWO. A Board of Governors hires/fired the President (kind of CEO) who had CR. We are all stakeholders in UWO. BoG makes sure Pres does things for stakeholders. Similar to Public Corp which had a Board, which is elected by the shareholders (so they may represent, hire/fire CEO)  Franchise (parent firm, with a contract to make their franchises/franchisees, what incentives will it give them. Some restaurants are actually corporate owned)  CR and RCR are very complicated (there is a messy situation where they are divided between the parent company and the franchise owner)

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Class 3 

Org Objectives o FP- max profit (looking for opportunities to make money) o NP(FP in disguise?)- Typical shorthand is to max service provision  But: 1. subject to no going broke  2. Multi-service what product mix makes the most  3. Quality of services, is higher quality worthwhile (cost effective) o SOE- not the clearest mandates

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NP vs FP o Direct care is 0.34 hours more per resident per day then FP o Support staff is 0.23 hours per resident per day more than FP o Key: functional level of dependance (how much do you rely on support staff), is it greater in NP? Self-selection bias

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Hospital readmission o Difference based on type of hospital (FP have higher readmission in US) o Self-selection bias: in US you can read who is the best, and they may get the hardest cases. We don’t know the difference in cases.

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Class 4  Separation of ownership control o Corp. FP  RC rights (shareholder- you want to earn something. Yet you have no ability to say how the org is run, that’s up to the CEO in control, which determines what they get)  They do have the right to exit- not enough return? You can sell them.  Right to a share of dividends, but senior management decides if you get the dividend (you don’t control dividend policies)  In principle, you get a vote. Vote at the meeting (1 share, 1 vote)  Back to motivation of FP: max profit (max pi)  = price (amount)- cost(amount) = p(q)-c(q)  How does a shareholder know that the decisions made by the CEO are the ones that max profit? The problem of information. Problem of enforcement (at the end of the day you see what was done not what could have been).  Public Corp  RC rights= shareholders o The board is the representation of shareholders. They hire/fire CEO. There is a board election (but a very limited way of representing, the board is often selected and you just say yes/no)

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o They have to decide under what condition is the CEO doing a bad job, or what orders to give to make sure he does a good job. Tell him to max shareholder value o Shareholder value: it is equal to the present value of its (the orgs) potential future cash flow stream discounted by the markets required rate of truth (not max profit or stock price)  Control rights= every employee o Big control is CEO (or big management)  Max SV (Theo) = Pi0 + BEPi1 + B^2EPi2 + B^3EPi3………….  0 < B < 1 (discount factor). Expected, uncertain  E means expected (expected value of profits)  Do these numbers get bigger or not?  Tell CEO we want to maximize this expression. How do they know it happens? Incentivize CEOcompensation based on S + rPit (salary and a share of the profit. R = share, 0 < r < 1)  CEO compensation (Profit sharing)  C = s+rPi0 + Bs+rBEPi1 + B^2s+rB^2EPi2 +….  (s+BS+B^2s+…..) + r(Pi0 +BEPi1 + B^2EPi2 +B^3Pi3…)  Give a share of shareholder value, so he wants to max his own return. Now have the same interests.  Problem: they don’t really do this, because if you had negative bottom line do you make the CEO pay? What is the B? It's typically idiosyncratic, and occurs at different rates. As we mature, the beta gets bigger.

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And the CEO could have a rate that discounts the future more than the board wants. o Compensate CEO with Salary + shares  It seems the clearest way to unite ownership and control within the CEO. He has the incentive to make decisions in interests of shareholders because he is one too. (there are variations to do this) o Two solutions  Pi (profit) shares (CEO)  Do stockholders want CEO to max SV  Stock in corp. (CEO)  Stockholder heterogeneity = different people have different preferences as to how they would like their returns  Dividends and capital gains are for both  Boundaries of Org o Make vs buy o Inside vs outside o Supervision vs contract o Vertical integration = a complex decision  Economies of scale (IRS- increasing returns to scale)  Hold up problem  Transaction costs  Relationship specific assets

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Class 5  Economies of Scale (IRS) – C(q)/q decreases as q increases o C(q)/q, cost per unit on average  q = quantity product/time  C is the total cost of output 

 Hold-up Problem- relationship specific assets (RSAs) o Car co. – firestone (buy) or In-house (make) o Not an issues: facility construction costs

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Class 6  EoS: if present (often not) in the particular firm/tech in the right sort of quantity range, the implication is they make vertical integration less likely (buy the input rather then produce)  Relationship specific assets can lead to the Holdup Problem which leads to vertical integration (solving HUP)  Transaction costs: cost to a transaction, but refers to specific costs o Any costs that are incurred by either party to the transaction (buyer or seller) that have (all three):  Are only incurred if the transaction happens  Are not a payment from one party to the other  Not a cost of production o Ex. Cost to you on getting there, delivery service (third party), time costs, taxes o Contracting costs- the costs of completing the contract, satisfying the contract (costs of drawing up and costs of monitoring) o TC are complex (hazy), if present leads to vertical integration  Delta Transaction costs o Inputs: Jet fuel powers the propellors, refiners make the jet fuel (or gasoline), using crude oil for the refiner o Trainer-Penn o Claim one: reduces fuel costs- due to avoiding the refinery profit (refinery has some cost and sells for greater than average cost of production) o Claim 2: reduces uncertainty (of price).  But jet fuel is variable because crude oil prices are variable.

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 Futures markets o Claim three:

Class 7  Family CEOs o A time-use analysis…. o 41% of the CEOs o 16% are professional  Hired an outsider o The rest  Whether publicly or privately held o The date  Every date of a randomly selected week they record every activity the CEOs undertake through daily interviews with the CEO themselves of their Personal Assistant  This gives a rather accurate measure of the number of hours worked during the week for that CEO o The findings  1. Family CEOs…  2. The average difference…  A. family ceos..  B. Family ceos…  Under the graph, to the left of the line, the total proportion of CEOs that worked that or less are the area under the curve  Stochastic dominance: no matter how you cut it up there is always the same findings o Author’s claim

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 The fewer hours of work put in by the family CEOs are driven by differences…  A bit of self-selection bias- maybe family firms are in certain kinds of businesses that lend to CEOs time off. They simply require less work  No- professional CEO in family-owned firms work just as hard as professional CEOs in non-family-owned orgs  One may argue that family CDOs work fewer hours because they can delegate their responsibility to other family members more easily  Differences in the number of family members in management explain a small part of the difference in hours worked  The authors also argue that the difference in work hours between family and professional CEOs depends on the opportunity cost of leisure (what you have to give up, the next best alternative)  Family CEOs working in larger firms and in more competitive industries – where the opportunity cost of CEO leisure is higher because slacking off would presumably……  Data from the Indian firms shows:  The difference between family and professional CEO work hours is significantly larger on days on which cricket matches are broadcast o The opportunity cost of the leisure time could be higher for a professional CEO o Does this really matter to the firm?  Perhaps the number of hours worked by a CEO has little effect on any firm’s performance  They find hours…  The elasticity of revenues per employee…

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 So the 9% extra in hours worked by non-family CEOs (on average) translates into an (average) increase of 3.24%...   If you get CEO to work 1% more hours per week, It results in a 0.36 more on average in revenue per employee o The reason for the differences in CEO behavior:  Three classes of CEOs  Family members in family firms  Professionals in family firms  Professionals in non-family firms  Professional are more likely to face termination if firm performance is low.  Simple Pricing (consumer POV) o 1. Buyer preferences: have nothing to do with prices, to do with what we consume o 2. Prices and income: prices vs consumer income  Buyer preferences o Two goods, where x-product is under investigation, q is the units of x consumed/time period, e is the $ to spend on “not x” o Binary choices between “bundles” (a pair of numbers, q and e) epends on the person and tradeoff

o utility function and indifference curves (can use one to find the other)

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o offered that choice, Jake doesn’t care. The point outside the indifference curve is what he would choose  indifference maps- multiple indifference curves

o There is different willingness for the same increase in product o Shape of indifference curves: if you take away that much e you have to give that much q to be on the curve. But because of the shape the same decrease in e there can be even more q required to get back on the indifference curve(when they have less, they value it more). This shape gives a better representation of choices o Label as some as utility curves/functions (Uj or Ul)

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