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chapter 1: getting started, Solutions: Incentives (bonuses, stock options)…
chapter 1: getting started
organization: constructed mechanism to achieve goals of organization
control
coordination
Coordination: Markets vs Organisations
Two coordination systems:
Markets (External Coordination):
Use prices, contracts, and competition.
Buyers and sellers interact freely.
Each actor pursues self-interest → invisible hand aligns supply and demand.
⚠️ Problem: Markets have transaction costs (searching, bargaining, monitoring).
Organisations (Internal Coordination):
Use authority, hierarchy, and planning.
Managers direct employees instead of negotiating each transaction.
Reduces uncertainty and saves transaction costs.
Coordination and Information
Coordination requires information about:
Who does what
When and how tasks connect
Performance and outcomes
Economic Approach (Douma & Schreuder)
Information asymmetry → when one party knows more than another (e.g., agent vs principal).
Leads to agency problems → managers (agents) may act in their own interests, not the owners’.
Agency Theory (Jensen & Meckling):
Information costs determine organisational design:
Behavioural Approach (Buchanan & Huczynski)
Focuses on communication barriers, trust, and informal networks.
Even with perfect systems, information can be distorted by bias, fear, or power differences.
Social capital (trust, norms, relationships) improves communication and coordination.
Informal systems (gossip, friendship networks) can often solve problems faster than formal systems.
Organisational Control and Coordination
Definition:
Control = Ensuring actions of individuals are consistent with organisational goals.
Two types of control:
Formal (Economic) Control
Rules, targets, contracts, incentive systems
Objective: maximise efficiency and accountability
Tools: performance appraisal, pay-for-performance, KPIs
Informal (Social) Control
Values, culture, peer pressure, leadership
Objective: build loyalty, cooperation, shared purpose
Tools: socialisation, culture-building, mentoring
Douma & Schreuder
Control systems reduce opportunism (self-serving behaviour).
Incentive alignment is crucial in principal-agent relationships.
But too much control increases bureaucracy and cost.
Buchanan & Huczynski
Informal control (norms, trust, teamwork) reduces the need for strict monitoring.
Leadership and culture are softer forms of control that motivate from within.
Purpose of the course:
To understand how and why organisations exist, how they coordinate human activity, and how they can be designed effectively.
we see it through
economic
efficiency, costs, coordination, incentives, and market mechanisms
psychology
individual behaviour, motivation, perception, and communication
sociology
culture, structure, power, and social norms
Division of Labour, Specialisation, and Productivity
Key Concept:
Introduced by Adam Smith in The Wealth of Nations using the “Pin Factory” example.
Dividing production into smaller tasks allows:
Specialisation → workers master one skill
Efficiency → less time wasted switching between tasks
Mechanisation → machines designed for specific tasks
Productivity increases dramatically
Economic View (Douma & Schreuder)
Division of labour leads to economies of scale and efficiency.
Firms exploit comparative advantage — each worker or unit focuses on what they do best.
But it creates dependency, requiring coordination mechanisms to link tasks together.
Behavioural View (Buchanan & Huczynski)
While division of labour increases output, it can also:
Create boredom and monotony
Lead to alienation (Karl Marx) → workers feel detached from the purpose of their work.
Reduce motivation and creativity
Increase turnover and absenteeism
Human solution: Enrich jobs, rotate tasks, and design work to include variety and responsibility.
Balance:
Too much specialisation = dehumanising
Too little = inefficient
Managers must find the optimal mix between productivity and human satisfaction.
Hierarchy and the Boundaries of the Firm
Why Hierarchies Exist
Hierarchies are internal coordination systems that replace the market.
Tasks are grouped and controlled under managerial authority.
Economic Perspective (Douma & Schreuder)
Hierarchy reduces transaction costs but introduces administrative costs (bureaucracy).
Firm boundaries depend on the trade-off:
If market exchange is cheaper → outsource.
If internal control is cheaper → keep inside.
This defines the “boundary of the firm”.
Williamson’s Transaction Cost Economics later formalised this.
Behavioural/Social Perspective (Buchanan & Huczynski)
Hierarchies also provide:
Structure, stability, and clear roles
Identity and belonging for employees
But risks include:
Reduced innovation
Poor communication between levels
Power concentration and resistance to change
💡 Key point:
The ideal structure minimises cost and maintains motivation.
Solutions: Incentives (bonuses, stock options) + Monitoring (audits, reports).
Goal: Align agent’s behaviour with principal’s objectives.
Complex firms invest in information systems to reduce asymmetry.