Chapter 4 - Incentives (III. Trust, cooperation, etc) (2016)

Apunte Inglés
Universidad Universidad Pompeu Fabra (UPF)
Grado International Business Economics - 1º curso
Asignatura Introduction to business law
Año del apunte 2016
Páginas 5
Fecha de subida 20/04/2016 (Actualizado: 20/04/2016)
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IV. Incentives - Trust, Cooperation and other problems INDEX 11. Agency ........................................................................................................................ 2 12. Prisoners’ dilemma ..................................................................................................... 3 CHICKEN ........................................................................................................................ 4 STAG HUNT ................................................................................................................... 4 13. Public goods ................................................................................................................ 5 1 avillagrasa IBE, 1st year - 2nd Term 11. Agency With perfect information everything is observable and there’s no asymmetry.
However, since reality is not like this, you - as a worker - can act opportunistic and send fake signals (I pretend to work when I’m not). It can also appear the free rider problem. To avoid this we can: a. Monitor: Control people (but it has a cost). We can monitor shareholders, bondholders, board of directors, government regulators and outside auditors; who have diverging goals and so incentive problems may appear. Shareholders have the fiduciary duty and managers have a fiduciary trust. This means that the managers have to act in principal’s interest.
b. Contract: the principal ties the agent pay to his performance c. Company takeover: A company sees that another is not doing well (it’s bad managed) and they decide to buy it. There are two ways of doing that: i. Friendly takeover: The other firm agrees on being bought ii. Hostile takeover: The other firm doesn’t want to be bought To avoid opportunism you have to pay, at least, one unit more than the reservation wage and effort.
MATHS EXAMPLE: Workers utility: U=(q - e2); the worker needs at least 1.000$ to show up for work, so we must compensate him 1.000+effort.
C=1000+e2, TR=100e, Benefits: 100e-(1000+e2)  optimize: 100-2e=0; e*=50. If we want an effort of 50, we have to compensate with a wage of 35.000$. We don’t ask for more effort because that would cost us more money that what the additional effort would give us.
To avoid opportunism (if effort can be observable) we could give a base salary and then give compensation according to the output. However it has some drawbacks: maybe workers exert too much effort and you have to compensate above the optimal, or output may be affected by external factors. If the worker is the risk bearer and so he keeps the profits, the firm may not be interested in make profits (opportunity cost of investment1) this is opportunism from the shareholders’ side.
PROBLEMS WITH OWNERSHIP 1. Wealth constraint: we can’t pay 2. Risk aversion 3. Team production: your output may be conditioned to other’s (if another does not do his part, I can’t do mine) 1 Prefereixes invertir diners en una altra cosa que et dongui més beneficis que en pagar-li al treballador 2 avillagrasa IBE, 1st year - 2nd Term 12. Prisoners’ dilemma My decision depends on someone else’s. This is studied in game theory: it depends on if I have to take the decision at the same time, after or before you.
CONCEPTS - Rules of the game: when do we have to make the decision? - Player’s strategy (according to the rules of the game). Maybe other’s strategy makes me change mine - Player’s payoff: the result of both player’s payoff according to the strategy - Dominant strategy (best strategy, regardless of what the other does) In this case they can choose to cooperate (between them) or not. If A cooperates, he may go to the jail 10 or 1 years, while if he doesn’t cooperate, he might go 5 or 0 years.
The same for the player B. The optimal thing to do would be to confess (not cooperate), because regardless of what the other does, I can go less years to the jail. If I don’t confess but the other does, I would go to the jail. Therefore, the dominant strategy (individually) is to confess, so they will both confess. Adopting the dominant strategy leads to the Nash equilibrium (5,5 in this case). This is the best they can get to (because they would have to be sure that the other would confess to achieve the best outcome  trust issue). This is also applied in cartels (they cooperate but there’s an incentive to do the opposite). We not always have dominant decisions because I don’t know what the other would do (in this case I know for sure what the other is going to do).
If the agreement is good for me I should suppose that it would be good for everyone, so that nobody would like to deviate to obtain other payoff (which conditions our strategy).
Prisoner’s dilemma: DC>CC>DD>CD 2 Chicken: DC>CC>CD>DD Stag hunt: CC>DC>DD>CD 2 POSSIBILITIES: CC (Cooperate, Cooperate); CD (Cooperate, Defect); DC (Deflect, Cooperate); DD (Deflect, Deflect) 3 avillagrasa IBE, 1st year - 2nd Term CHICKEN Consists in doing the opposite that the other does, even if the best would be to do the same as the other.
People are irrational a lot of times. For example in auctions (subhastas) prices increase very much because people compete and want to be the highest bidder, we’re reacting emotionally, which is making us have lower payoffs.
However, sometimes it’s rational to do the opposite. For example if we’re driving from a narrow road and suddenly another car appears driving in the opposite direction, if we both swerve (girar) it’s bad but if neither of us swerves we will collide. In this example then, we should not do the same.
STAG3 HUNT The optimal here would be to cooperate (because they need each other to hunt the stag which has more value). By them acting equally we would achieve the efficiency.
In this example we have that, if they don’t cooperate they can only hunt rabbits, but if they cooperate they can catch a stag, which is very valuable.
3 Cèrvol mascle 4 avillagrasa IBE, 1st year - 2nd Term 13. Public goods The strategy is different when goods are public. This happens when we can’t get them in a private way. They are not excludable (you have to allow everybody to use it) and they are non-rival (you can enjoy as much as I do at the same time  with private goods not because, if you use my clothes, I can’t use them, so my enjoyment is less).
There’s a problem of interest between the individual and the group, because I want to maximize my utility even if it means to lower group utility. This is the common pool’s problem = free-rider problem. To achieve the higher utility people should contribute, but you may want to deviate. However in this case the best thing to do is to cooperate and contribute. This is why we pay taxes to use the public goods not according to how much do we use it but according to our rent (because we suppose that you can use it as much as you want). If somebody over-uses we’ll call him free-rider.
This also has to do with the prisoner’s dilemma.
5 avillagrasa IBE, 1st year - 2nd Term ...