Transactions, Incomplete Contracts, Coordination, Vertical Relations,
Information Economics
State, Signal, Action
Information signal provides some valuable information about the true state, and decision maker benefits
Basic Assumption: No objective misalignment in decision making
Principal-Agent Problem
Principal is profit maximizing by choosing a compensation scheme for the agent
Subject to agent paid better than outside option and agent maximizes payback by choice of effort
Another way - 2 stage game: Princ chooses S, agent chooses a, outcomes are observed.
Findings
No IC Condition - choose best action ST agent paid reservation wage
When principal is risk neutral, numerator is 1, so compensation is a constant. Principal takes all risk, agent - no risk. y (other performance information) adds no value.
G'(x-S(x,y))/U'(S(x,y) = Lambda
IC condition added
Term gets added to the Lambda. A fixed compensation will make the agent shirk, compensation needs to be based on x and y as well.
y needs to be information in addition to x to be useful
y needs to be something that agent effort 'a' can affect
Revelation Principle
For any non-truthful reporting strategy, principal can design a contract that will induce more truth telling
Coordination
Specific vs General knowledge
Time, location specific
granular, poor aggregation properties
Dispersed
Continual change, dontinual decisions
Passing required information downward
Prices
Only the relative extent of unavailability, not why, etc
An inducement to use less of the product in shortfall.
The Problem
How best to make decisions through economic interactions of people when there is partial information
Solution 1: Collocation of decision making rights with knowledge important to these decisions
Problem: What if there is no alienability? Like intra-firm
Solution: Hayek says decisions rights will move to agents with knowledge. Moving up or down depends on COSTS of moving knowledge
The intra-firm Principal-Agent Problem
Causes: State not observable, action not calculable, objectives misaligned,
Effects of IT on centralization vs decentralization: Ease of specific knowledge transfer to CEO; improvements in control technology
Contralization vs Decentralization
Consider coordination between HQ and nodes
Problems
Information Asymmetry
Nodes know own demand (Anand &M 1997, Nault 1998, Nault & Deter 1994, Nault and Dexter 2006,), or own productivity (Harris et al)
General Setup1: There are investment complementarities between HQ and nodes. But each doesnt know the other's investment level. CA sets m,t. Org forms include Hierarchical, decentralized, mixed (Nault papers)
Externalities
Node's investment increases other nodes profits and HQ profits, leads to under-investment(Nault 1998, Nault and Dexter 1994, Nault and Dexter 2006)
What should investment levels be for nodes and HQ?
Nodes do not know HQ's production cost (A&M1997)
HQ does not know node's productivity
General Setup 2: Nodes place orders with HQ, or report productivity with HQ (A&M1997, Harris et al 1982)
Findings
IS reduces coordination cost
Collocation can be good. But if info can be moved through IS, decisions can be made at either end
Using revelation theorem, nodes can be made to reveal true productivity
t=0 is ideal, to reduce horizontal externality
Sharing of information between supply chain partners can increase efficiency of supply chain
Inter-firm coordination : Boundary of the firm, transaction costs, incomplete contracts and asset ownership
Transactions
Behavioral assumptions
Bounded Rationality
Opportunism
Uncertainty
Frequency
Asset Speficity
Location
Physical asset
Human Asset
For market (buying), as specificity increases, governance cost increases relative to making. Production costs are assumed to always be lower in the market. Net, making starts to look better
Cooperative Game Theory
Problem: To find a function that will divide value added to members
Axioms
Efficiency: Allocate Everything
Dummy: Add nothing, gain nothing
Symmetry: Labels do not matter
Function should be additive
Shapley Value
Sum over all allocations ((prob of being in a coalition)*(value added to that coalition)
This is one of the characteristic functions that will satisfy the above axioms
Non-Cooperative Bargaining Solution
Here, axioms lead us to the solution: Split the difference!
Problem: Given incomplete contracts, how should we allocate asset ownership to achieve high investment levels
Incomplete Contracts
Stem from bounded rationality, some things cannot be fully contracted: care, creativity, quality
In such cases, uncontracted quasi-rents (Residual rights )go to property owner
An agent with no access to assets risks no return on investments on HR skills. The risk can be mitigated if he is assured access to the asset inherent in ownership.
Core: the best set of allocations that cannot be improved by reducing the size of the coalition
Solution and Findings
Integration can reduce holdup problems.
Agents under-invest if they find that some of the returns from their investment will dissipate
Asset ownership gives the right to exclude others from using it
General Setup
Stage 1: Agents invest non-cooperatively Xi; Stage 2: Agent value is realized based on Shapley value.
Stage 1 is value maximizing non-cooperative investment. Put your money where the best return is, much like a stock market.
Stage 2: Ex-post value generation is visible, greater the value generated for the coalition, greater the return - an axiom. Presence of industry bodies and standards even in highly competitive industries exemplifies this. X's are observable at date 1 to all.
FB: FOC is when marginal benefit of each investment is equal to cost across all agents
But in reality, at date 0, each agent i chooses Xi to maximize Bi(a|x)-Ci(Xi). The benefit is highly reduced because of uncertainty
If only one agent has investment, he should own all assets
Not more than 1 agent should have veto power over an asset
If an agent is indispensable to an asset, he should own it
Strictly complementary assets should be owned together
If an asset essential to an agent i is controlled by agent j, then agent j should control all assets
Bakos and Nault 1998
RQ: Derive optimal ownership structure for the internet
Vi(S,A|X) = Sum(LAMinAn)Sum(MUikXk)Xi^1/2
IT reduces in-house production costs as well as transaction costs, favoring both markets and hierarchies, net impact is inconclusive
They explore through a functional form, how H&M1990 can be applied to IT networks. LAMin scales the impact of asset An on value realized by i. MUi scales the impact of each agent's investment Xk on i's value generated.
Methodology
FOC: FB: Marginal Benefit = Marginal Cost
FOC: Marginal increment in Shapley value = Marginal Cost
Comparing the above, there is underinvestment
Brynjolfsson 1994
If agent 2 has asset ownership
Agent 1: 1/2(MB) = MC
Agent 2: MB = MC
Results: Asset Specificity in supply contracts without asset ownership are prone to under-investment
Bhardwaj et Al 2007
Research Question
Does IT synchronize externally oriented functions like marketing and Supply chain, with internally oriented functions like Manufacturing
Does IT enhance manufacturing's coordination with supply chain and marketing in order to increase manufacturing's performance
Specification
3 Direct effects, interactions, controls and Inverse Mills Ratio
Yao and Zhu 2012
Research Question
Do electronic linkages reduce the bullwhip effect?
Defn: Bullwhip effect is defined as the amplification of demand variability from a downstream site to an upsteam site
Findings
EL use with supplying industries tends to reduce bullwhip effect
EL use with buying industries tend to increase bullwhip effect
IT seems to mitigate this effect
Hypothesis justification: IT reduces coordination costs : Cost of exchange and processing information. 2) Monitoring costs 3) Increasingly standardized, reducing asset specificity 4) Order batching
Anomalies
Buyers have more options when using EL, they can switch, causing variance in demand
Defn: A Transaction occurs when goods or services are transferred across a technologically separate interface