Appunti del corso Business e Industrial economics

Module B

If economic resources are scarce, the market solves these issues with the mechanism of prices (equilibrium price and quantity of a good with interaction between buyer and seller).

What to produce: One dollar, one vote.

How to produce: Efficiency and competition.

How to distribute wealth: Firms are a hybrid solution between a centralized and decentralized economy.

Pareto efficiency: The allocation of resources is efficient if it is not possible to improve the utility of an agent without reducing the utility of another.

Pareto efficiency problems:

• Cannot solve inequity issues.
• Limited predictive power - between many Pareto efficient allocations, which one emerges?

Efficiency principle: If economic agents can trade effectively, they will reach a Pareto efficient allocation of resources.

First welfare theorem: By trading in perfectly competitive markets, economic agents can attain a Pareto efficient allocation of resources.

Second welfare theorem: For any Pareto efficient allocation...

1. Market imperfections -> market failures
• Externalities: cost (negative) or benefit (positive) imposed upon someone by others’ actions
• Consumption -> (smoke money example)
• Production -> merger is a possible solution
2. Coase’s insight: result from inadequate specification of property rights
3. Coase’s theorem: if agents preferences are quasi linear in money then there is the same allocation of resources no matter who has the property rights.
4. Information asymmetries
• Adverse selection (example market for lemons, skills for workers) -> remedy: signalling -> separate high and low quality agents
• Moral hazard -> remedy: incentive contracts
5. Public goods (not excludable and non-rival in consumption, probable policy maker intervention) -> free riding problem (more likely if many agents are

involved)
Non-competitive markets -> natural monopoly
The policy maker tries to remedy to market failures -> aim to maximize social welfare

MODULE C
Theories of the firm: corpus of economics and managerial theories that open the firm black box (of microeconomics model)
Explain why firms exist
Recognize that firms have multiple objectives beyond profit and sometimes managers do not aim to maximize profits

Objectives of the firms related to profits:
Surviving -> function of size and age, entry in an industry (entry and exit rates)
Growing (sales and employees)
Promoting social responsibility

Acknowledge the prominence and heterogeneity of individuals in the firms
Firms’ heterogeneity within and across industries

Transaction costs theory
Firms exists because market transactions entail transaction costs which are eliminated or reduced by internalizing the transaction in the firms. The assumption is that economic agents are boundedly rational and boundedrationality causes transactions costs because it is impossible to draft complete contracts, the higher the uncertainty, the higher the transaction costs because of the possibility of opportunistic behaviour of exploiting contract incompleteness. Transaction costs: - Ex-ante - Ex-post Relational specific investments: cause asset specificity which causes the hold-up problem: the party investing depend on the other that can breach the contract. - Physical capital - Human capital - Site specificity We chose market if the level of contract incompleteness and the treats of opportunism are low, we chose hierarchy otherwise. (NB. In the firm you have possibility of inefficient decisions and information asymmetries). Agency theory Agency relations in which the principal delegates a task/decision to the agent. Owner-controlled firms: owners are also managers Managerial firms: owners hire professional managers to run the firm. Managers are not interested only in maximizing profits; they also aim to

maximize other variables related to sales:

• One-period sales -> Baumol model 1
• Cumulative sales -> Baumol model 2
• Balanced growth rate of sales -> Marris model

Three main problems in p-a relations:

• Conflicting goals
• Information asymmetries -> agent is more informed and principal cannot control
• Diverse risk attitudes -> principal is risk neutral; agent is risk adverse

Remedies to CEOs moral hazards -> align interests, increase information, transfer part of risk

• Choosing the appropriate capital structure =equity/debt

Equity: financial capital held by owners who do not manage the firm -> if increase the CEO has less interest to act in the interest of the firm.

Debt: financial capital provided by external investors -> if increase the CEO risk less

Low agency costs of equity -> low risk of managers pursue their private benefits

Low agency costs of debt -> low cost of bankruptcy

Mixed-payment schemes for CEOs

• Base salary
• Annual

bonus of yearly performance -> short term prospective Long term bonus of multi-year performance -> long term prospective Equity based payment -> firm shares Monitoring CEO with board of directors (internal and external members, NB. internal can be influenced, external can lack information) Efficient markets for corporate control Efficient labour market for CEOs (internal->less cooperation || external->risk aversion) Incomplete contracts theory The owner is the residual claimant who has the right to decide how to allocate the surplus generated by the transaction Conceives the firm as a collection of contracts linking owners, employees and productive assets. Contract incompleteness implies that the owner has residual contract rights In case of a transaction answers the question: what option is better between a market transaction (in which no party owns the asset and they equally share the surplus generated by the transaction) or an internal

transaction (in which one party owns the asset and decides how to allocate the surplus), and in case 2 who should be the owner between the 2 parties? If relational specific investments are essential it is better an internal transaction, in case of an internal transaction the ownership should be assigned to the agent whose relational specific investments are bigger to better maximize the surplus.

MODULE D

Firm boundaries: which exchanges happen in the market and which ones are internalized in the firm, relates to the size, growth, lifecycle, market power of the firm.

Vertical integration: internalizing operations

• Upstream
• Downstream

Approaches to study vertical integration:

• Transaction cost theory

Choice between market transaction and vertical integration (hierarchy), in order to do that we compare:

• Technical efficiency: efficiency in the production process -> market specialists have lower production costs than vertically integrated firms
• Agency efficiency: efficiency of the

1. exchanges of goods along the value chain -> markets
2. specialists engender transaction costs (depending on asset specificity [ > >]), vertically integrated firms engender organizational costs (coordinating and monitoring)
3. NB. If it is >0 we choose market transaction, If it is <0 we choose vertical integration
4. NB. If asset specificity is low T is high and A is positive, if asset specificity is low T is low and A is negative, in increase in production (size) reduce the level of asset specificity.
5. Incomplete contract theory
6. Vertical integration with a firm that owns another firm occurs when relational specific investments by the first firm have a greater impact on value creation than those of the second one. -> in transaction cost theory doesn’t matter who has ownership, in incomplete contract theory it does.
7. Market structure
8. Vertical foreclosure: use of vertical integration to reduce competition, in the short run by raising competitor’s costs, in the long run

increasing the entry costs of potential competitors.

Monopoly up and down stream -> double marginalization

In this case market transactions are less efficient than vertical integration (higher price, lower quantity sold, sum of single profits is lower than integrated firm)

Monopoly up or downstream and competition the other part -> ownership of an essential facility

Anti-competitive use of the facility by charging a high price to access the facility and denying access to the essential facility to entrants by charging a price to high for them

Competition up and down stream

Alternatives to vertical integration

• Tapered integration: a firm produces/distributes part of its inputs/outputs and buys/distributes the other part from market specialists
• Vertical restrains: agreements between upstream and downstream firms

Two-part tariff

Royalty agreements

Slotting allowances

Strategic alliances: stable contractual agreements according to which firms cooperate,

coordinate and share information without losing their autonomy

Diversification: operating in multiple industries/geographical areas

• Related diversification: sharing phases of the value chain
• Unrelated diversification: not sharing phases of the value chain

Types of diversification:

• Internal venturing
• Joint venture
• Mergers and acquisitions

Industry: all the firms producing goods that customers perceive as substitutes (demand side, supply side or geographical)

Diversification indexes

Firms diversify because of:

• Efficiency reasons -> economies of scope
• Managerial reasons -> objectives of the firm’s manager

Internationalization forms:

• Export
• Foreign direct investments (FDIs) -> horizontal or vertical, efficiency or strategic objectives, can decrease transaction costs in international exchanges.
• Greenfield
• Cross-border acquisition
• Joint ventures

Intermediate forms

NB. FDIs relate to MNCs

Mainstream theories on multinational corporations

(MNCs)Hymer’s theory: FDIs are motivated by firms’ possession of ownership advantages

Vernon’s theory: the production of new products requires skilled labour, financial capital, many proximate costumers. Some critiques are the fact that this theory establish a hierarchy of countries in terms of innovation, consider innovation only driven by demand factors and not supply, deals with a single new product.

4 phases of Vernon’s theory:

1. Introduction -> innovator benefits from monopolistic position, uncertainty on the product in high and proximity to customer is crucial, internalization is not worthy.
2. Growth -> features become stable and proximity is less important, economies of scale and monopolistic position, internationalization can increase innovators’ profits.
3. Maturity