Economics hierarchies

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Economics Hierarchies

Gregorio Miguel García Ramírez
Erasmus Student
Introduction to the Economics of the Firm


In this chapter, therefore, an attempt is made to outline some more recent developments (still mainly within the neoclassical tradition) which specifically concern information problems, incentives and internal structure.
Principles were sought forestablishing the correct division of labour, instituting the appropriate ‘span of control’ (number of subordinates per supervisor), defining a clear command structure and so forth. The result was a somewhat impersonal, mechanistic approach to organizations, which was criticized for overlooking more human and social factors.
Simply to make sense of the varying institutional arrangements which are observedin practice. Our starting point is an appreciation of transactions costs (Chapter 2) and the problems of contract enforcement to which they give rise (Chapter 5).
Bureaucracies or hierarchies have been recognised as having certain standard features:

1.- The organization is made up of people assigned to the various layers in the hierarchy. These layers may be defined in terms of‘authority’, so that those assigned to a higher rank supervise those in the subordinate layer. In this case, the number of layers in the organization will depend upon the size of the base and the ‘span of control’ exercised by supervisors.

2.- The number of people in higher positions in a hierarchy is fewer than the number in the immediately subordinate position.

3.- Positions higher up ahierarchy are filled predominantly by promoting people from lower positions in the hierarchy.

4.- Hierarchies are characterised by Weber’s quality of ‘impersonality’. People are treated alike once they have been assigned to a position in the hierarchy.Williamson sees this ‘impersonality’ in the lack of scope for individual bargaining and the necessity of accepting ‘standard’ terms and conditionsof employment applicable to a particular hierarchical level


2.1 Payment Schedules, Moral Hazard and Effort

Suppose that only the final outcome of the employees’ effort is observable, then each point in the box diagram can be interpreted as implying a payment schedule made up of a time-rate and a piece-rate.
In the general case, where any number of outcomesmight occur and effort levels can vary continuously, there is absolutely no reason to suppose that the efficient contract will imply a linear incentive structure. Indeed, the informational and computational requirements involved in ‘calculating’ the best contract will be formidable and the result could be a highly complex structure.
Where effort can vary continuously the efficient contract will beso adjusted that the additional risk sharing losses associated with inducing an extra unit of effort from the employee are just equal to the marginal benefits derivable from the extra effort.

2.2 Payment Schedules, Adverse Selection and Worker Sorting

Choice of incentive structure will also have an impact on the quality of worker recruited when this quality or ‘ability’ is unobservable andadverse selection is a problem.
Production is closely correlated to the "capacity" of workers. Higher output is thus linked to higher quality not to higher effort.
The average quality of the workforce is also expected to rise as highquality workers choose to work in firms offering piece-rates.


How monitoring could result in both parties to a contract becomingbetter off. It is this use of a monitor or supervisor which is the distinguishing mark of what Williamson (1975) terms a ‘simple hierarchy’. One
person or group of people does the work, and another person monitors and assesses performance.

3.1Monitoring and Moral Hazard

Monitoring is a response to the problem of ‘moral hazard’. The risk-sharing losses involved are the result of moral...
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