Managerial Economics 12 Chapter 18

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CHAPTER 18--ORGANIZATION STRUCTURE AND

CORPORATE GOVERNANCE

Student: ___________________________________________________________________________

2. The merger between Proctor & Gamble, maker of products like Tide, Crest, and Pampers, and Gillette, the

26. Horizontal and Vertical Relations. Intel Corp. designs, manufactures and markets microcomputer

27. Horizontal and Vertical Relations. America Online, Inc., is a provider of online services to consumers in

the United States. AOL offers subscribers a wide variety of services, including electronic mail, conferencing,

news, sports, weather, stock quotes, software, computing support and online classes. These services can be

accessed from a range of personal computers using AOL's proprietary software. Microsoft Corp. develops,

manufactures, licenses, sells, and supports a wide range of software products, including operating systems for

personal computers and servers; server applications for client/server environments, business and consumer

productivity applications; interactive media programs; and Internet platform and development tools. Microsoft

also offers online services, sells personal computer books and input devices, and researches and develops

advanced technology software products.

28. Horizontal and Vertical Relations. International Business Machines (IBM) develops, manufactures and

29. Horizontal and Vertical Relations. Dell Computer Corp. designs, develops, manufactures, markets,

services and supports a wide range of computer systems, including desktops, notebooks and network servers,

and also markets software, peripherals and service and support programs. They are the world's leading direct

computer systems company and one of the top five computer vendors in the world. Compaq Computer Corp.

designs, develops, manufactures, and markets a wide range of personal computing products, including desktop

personal computers, portable computers, PC servers and peripheral products that store and manage data in

network environments. The company markets its products primarily to business, home, government, and

education customers. Compaq operates in one principal industry segment across geographically diverse

markets.

30. Horizontal and Vertical Relations. Barnes & Noble, Inc. is one of the world's largest booksellers. The

company's principal business is the retail sale of trade books, generally hardcover and paperback consumer

titles, excluding educational textbooks and specialized religious titles, mass market paperbacks, such as

mystery, romance, science fiction and other popular fiction, children's books, off-price bargain books and

magazines. Borders Group, Inc. is one of the largest operators of book superstores and mall-based bookstores in

the world based upon both sales and number of stores. Borders is a premier operator of book and music

superstores, offering customers selection and service that the company believes to be superior to other book

superstore operators. Each Borders superstore offers customers a vast assortment of books, customer service,

value pricing and an inviting and comfortable environment designed to encourage browsing.

31. Nature of the Firm. Dell Computer Corp. designs, develops, manufactures, markets, services and supports

a wide range of computer systems, including desktops, notebooks and network servers, and also markets

software, peripherals and service and support programs. They are the world's leading direct computer systems

company and one of the top five computer vendors in the world.

Critics of Dell argue that the company is "merely" a retailer bringing together computer manufacturers and customers. Would Ronald

32. Nature of the Firm. Amazon.com is a leading online retailer of books. The company also sells CDs,

videotapes, audiotapes and other products over the Internet, and on proprietary online services like America

Online. Amazon.com has a limited operating history upon which to base an evaluation of its business and

prospects. The company's prospects must be considered in light of the risks, expenses and difficulties frequently

encountered by companies in their early stage of development, particularly companies in new and rapidly

evolving markets such as online commerce.

Critics of Amazon.com allege that the company is "merely" an information processing device for bringing together book wholesalers

33. Transactions Costs. Centex Corp. is one of the nation's largest home builders, building and delivering,

through its subsidiary Centex Homes, over 10,000 homes per year. Centex's housing operations currently

involve the construction and sale of single-family and multi-family homes in over 50 different markets

nationwide. These activities also include the purchase and development of land.

Use transactions costs to explain the existence of firms like Centex.

When will less formal contracting arrangements supplant the need for a formal corporate structure?

34. Transactions Costs. Humana, Inc., offers managed health care products which integrate management with

the delivery of health care services through a network of providers, who in their delivery of quality medical

services, may share financial risk or who have incentives to deliver cost-effective medical services. It also offers

administrative services products including group life, dental, disability income, workers' compensation, and

pharmacy management services.

35. Virtual Corporation. Cendant Corporation provides travel and real estate services primarily in the United

States and the United Kingdom. It operates in six segments: Real Estate Franchise and Operations, Hospitality

Services, Travel Distribution Services, Vehicle Services, Mortgage Services, and Marketing Services. The Real

Estate Franchise and Operations segment franchises the real estate brokerage businesses, provides real estate

brokerage services, and assists in employee relocations through Cendant Mobility. Cendants's Hospitality

Services segment operates eight lodging franchise systems; facilitates the sale, exchange, and development of

time-share vacation ownership interests; and markets and manages vacation rental properties. The Travel

Distribution Services segment provides travel content and services to consumers, travel agencies, corporations,

and suppliers of travel products and services. The Vehicle Services segment operates and franchises its Avis

and Budget vehicle rental businesses. Mortgage Services provides home buyers with mortgage lending services

and title, appraisal, and closing services. And finally, the Marketing Services segment provides membership,

loyalty, and insurance-based products and services to financial institutions and other partners.

36. Virtual Corporation. The Walt Disney Company is a diversified, international family entertainment and

media juggernaut whose operations include world-famous theme parks and resorts. The company also includes

a filmed entertainment division, specializing in motion pictures and television shows, and home video products.

Disney also offers records, consumer products, a cruise line, radio and television stations, broadcast and cable

networks, publishing activities and professional sports enterprises.

37. Coase Theorem. One of the traditional arguments in favor of government intervention in the market

economy is that unregulated market activity can sometimes lead to failures, like pollution. Critics of

government failures to deal with pollution problems effectively argue that there exist private-market solutions to

the pollution problem.

38. Coase Theorem. Suppose a power plant reduced recreational opportunities by fouling a nearby river. A

natural result would be for local environmentalists and consumers to petition local authorities for regulations

outlawing or severely limiting such anti-social behavior. On the other hand, others might argue that there exist

efficient and effective private-market solutions to such pollution problems.

39. Agency Problem. In 2005, Qwest Communications International Inc. ended its pursuit of MCI Inc. While

the Denver-based company had worked hard to win Virginia-based MCI, Qwest walk away from a bidding war

with Verizon Communications Inc., a large New York-based phone company, when Qwest's increasingly

expensive effort seemed futile. Ending a furious three-month bidding war, long-distance phone titan MCI turned

down a $9.74 billion takeover offer from Qwest, a local and long-distance phone company, in favor of a $8.44

billion offer from the more financially secure Verizon. At the time, some of MCI's largest shareholders

criticized MCI's board for taking the lower bid and urged Qwest to persist, but Qwest declined.

40. Agency Problem. In 2005, former WorldCom Inc. Chief Executive Bernard J. Ebbers was found guilty on

charges of conspiracy, securities fraud and making false filings with the Securities and Exchange Commission

in connection with what authorities have described as the largest accounting fraud in U.S. history. He could

spend the rest of his life in jail.

41. Excessive Risk Taking. In 2005, The Wall Street Journal reported that two founders of Amerindo

Investment Advisors Inc., a money-management firm that makes outsized bets in technology stocks, were

charged with stealing millions of dollars from investors to make charitable donations and buy thoroughbred

racehorses. Alberto Vilar and Gary Tanaka were charged with fraud and arrested by U.S. Postal inspectors.

Vilar and Tanaka made names for themselves by betting big on biotechnology and technology stocks. Their

fund was an early investor in Web portal Yahoo Inc. and generated huge returns for its early investors,

including many institutions and high net-worth individuals. The duo later created a mutual fund, which in 1999

reported a 249% return to investors.

After amassing a huge fortune in the late 1990s, Vilar pledged hundreds of millions of dollars to charities,

including New York's Metropolitan Opera, Washington's Kennedy Center and New York University. Hurt by

the bursting of the technology bubble and an exodus of investors, the firm's assets under management dropped

from $8 billion in March 2000 to about $1.5 billion in 2005.

42. Other Peoples' Money Problem. In 2008, France's Société Générale SA said that a 31-year-old trader

named Jérôme Kerviel had cost the bank €4.9 billion (equivalent to $7.2 billion) by making huge unauthorized

trades. Société Générale's loss dwarfed the $1.3 billion Nick Leeson cost Britain's Barings Bank in 1995, and

forced Société Générale to seek a capital infusion of as much as €5.5 billion ($8 billion). Société Générale's loss

was only one of many huge write offs tied to a general breakdown in risk controls at gigantic international

financial institutions. In 2007-08, giant financial institutions around the world lost billions of dollars on

complex financial instruments tied to subprime mortgages and various poorly designed trading strategies. Such

losses had important and far-reaching economic ramifications. For example, Société Générale's frantic efforts to

unwind Kerviel's unauthorized trades over a 72-hour period rattled global financial markets, and spurred

dramatic moves by the Federal Reserve Board's Ben Bernanke to cut U.S. interest rates and head off a deep

economic recession.

Explain this Société Générale bank episode as a manifestation of the "other peoples' money" problem.

How could it have been avoided?

43. Incentive Compensation. Salary and bonus payments tied to short-term performance often constitute a

44. Incentive Compensation. Salary and bonus payments tied to short-term performance often constitute a

45. Corporate Governance. Empirical studies show a negative stock-price reaction for firms mentioned in

46. Corporate Governance. In a fully informed stock market, news regarding the enforcement of federal laws

against publicly traded firms would have no effect on target firm stock prices. A "rational expectations

hypothesis" predicts that investors would be unaffected by announcements concerning the enforcement actions

of federal agencies because current stock prices accurately reflect discounted future cash flows based upon all

relevant information. An absence of announcement effects tied to federal law enforcement actions would

suggest that the market is fully aware of illegal activity, the probability of getting caught, and the potential

sanctions tied to detection and conviction. Future cash flows lost following federal law enforcement actions can

include the costs of sacrificing illegal advantages over competitors, investigation expenditures, litigation

expenses, and lost reputational capital. An absence of abnormal returns tied to federal law enforcement actions

does not mean that there is no cost to being caught; it simply implies that the market correctly anticipates the

magnitude and probability of such costs. Here it is important to recognize that the term "caught" does not

necessarily imply guilt as well. Under the rational expectations hypothesis, market participants also know the

probability of innocent firms being investigated or sued.

How would you interpret positive stock-price effects tied to public announcements regarding the enforcement actions of federal

47. Stock-market Indicators of Efficiency. According to the Efficient Market Hypothesis, current stock prices

reflect all relevant risk and return information. This implies that near-term stock price changes are random and

independent. In a rational pricing environment, investing in the stock market is a "fair game" where the

expected excess return for each security is zero. Taken literally, this means that every stock at every point in

time is an equally good buy (or sell). Within this context, the stock market provides a useful context within

which to evaluate managerial decisions. "Good" decisions boost share prices, and "bad" decisions cause share

prices to fall.

48. Executive Compensation. Roberto Goizueta did a superb job as head of soft-drink juggernaut Coca-Cola.

49. End-of-game Problem. One of the most vexing problems facing boards of directors and stockholders is the

so-called "end-of-game" problem.

50. Organization Design. An effective organization design is one that allocates decision authority to that

person or team of persons best able to perform a given task or influence a particular outcome. Decision

authority allows individual employees to determine how and when to best deploy the productive resources and

valuable information at their disposal. Of course, decision authority confers responsibility. It is thus imperative

to monitor and evaluate performance. Managers and all employees must be held accountable for outcomes tied

to individual decisions. Accountability can only be measured in terms of the tangible and intangible rewards

derived from productive activity, and in terms of the penalties or sanctions tied to unproductive behavior. To

minimize the costs of unproductive conflict with the firm, it is essential that the design of the organization

effectively allocate decision making authority.

CHAPTER 18--ORGANIZATION STRUCTURE AND

CORPORATE GOVERNANCE Key

2. The merger between Proctor & Gamble, maker of products like Tide, Crest, and Pampers, and Gillette, the

26. Horizontal and Vertical Relations. Intel Corp. designs, manufactures and markets microcomputer

components and related products at various levels of integration. Intel's principal components consist of

silicon-based semiconductors etched with complex patterns of transistors. Microsoft Corp. develops,

manufactures, licenses and supports a range of software products, including scalable operating systems, server

applications, business and consumer productivity applications, software development tools and Internet

software and technologies. Together, Intel and Microsoft Corp. are sometimes described as comprising the

"Wintel" monopoly.

Describe how Intel and Microsoft share important elements of a vertical relationship.

Describe how Intel and Microsoft have important elements of a horizontal relationship.