Management - Appunti per esame generale

Management - General lectures class 1: An introduction to economic activity

What is management and economic activity?

Management: A range of decisions associated with the acquisition, allocation, and integration of resources (human, physical, financial, etc).

Acquisition: Really important for businesses based on people.

Economic activity: The production and consumption of economic goods.

Economic goods: A special class of goods (i.e. things you buy).

Production: Because nature does not provide us these goods, but it provides others (raw materials).

Consumption: When goods are used to satisfy our needs.

A model of economic activity: People aspire to a variety of goods -> Pursuit of goals gives rise to needs -> Many needs are satisfied by economic goods -> Goods are produced and consumed in economic activity.

Goals: People’s purposes and aspirations. They drive all human activities.

Needs: Dissatisfaction owing to the lack of something.

Maslow’s hierarchy of needs: One must satisfy lower level needs before passing onto the next level.

• Physical needs: Income from employment must be high enough to meet essential needs.
• Safety needs: A contract with some job security. Ensuring health and safety conditions are met.
• Belongingness and love needs: Working in teams or groups and ensuring good communication to make workers feel involved.
• Esteem needs: Recognition for work done well - status, advancement, and responsibility will gain the respect of others.
• Self-actualization: Challenging work that stretches the individual, this will give a sense of achievement. Opportunities to develop and apply new skills will increase potential.

What are economic goods?

• Economic goods: Useful but scarce, so they require human production.
• Free goods: Useful and not scarce.
• Primary goods: Satisfy essential needs.
• Non-essential goods: Satisfy non-essential needs.
• Complementary goods: You need both products to satisfy need.
• Substitutes: You only need one product to satisfy need.
• Differentiable goods: Producers can add differentiating features to the good.
• Non-differentiable goods: There are no differentiating features. (commodities)
• Consumer goods: For final use or consumption.
• Instrumental goods: Used to produce other goods.
• Disposable goods: Used once.
• Durable goods: Used many times.
• Individual goods: Use/consumption by single individuals.
• Collective goods: Use/consumption by many people at the same time.
• Private goods: Produced by private social bodies (firms, families, non-profit).
• Public goods: Produced by the state or its branches.

What economic activities are carried out?

Activities necessarily involved in the production of economic goods:

• Technical transformation: It changes and combines raw materials, systems, data, knowledge. Three types: physical transformation, spatial transportation, logical transformation.
• Transactions: You need transactions to buy input from suppliers and sell output to customers. Transactions link organizations to other organizations and individuals. In transactions you exchange: goods, financial resources, work, risks, public goods (free provision + tax).
• Complementary (support activities):
• Institutional structure design: Founding and giving shape to the organization.
• Organization and human resource management: Organizing and managing people.
• Accounting and information management: Keeping track of activities.

Class 2: Why firms exist. Organizations and economic specialization

Where does economic activity take place?

Economic activity can be carried out by both individuals and organizations; however, organizations dominate because they are more efficient (better achievement of results than through individual activity) and because of social needs (organizations fulfill human needs for sociality). Efficiency produces an organizational rent (The difference between what you get paid when working in groups and what you would get if it was unspecialized work). Organizational rent is important because it is always possible to redistribute it in a manner that each worker receives more than when selling the outcome of individual effort. Organizational rent also means that the outcomes of organizations are lower cost or higher quality than the outcomes of individual producers.

What are social bodies?

Four social bodies that carry out economic activity:

• Families: Main purpose is non-economic (moral, social), but they satisfy needs of family members, including economic needs. Non-core economic interests: other relatives, staff. Typical economic operations: consumption, income generation, internal work, saving and investment, insurance management, paying taxes, financing, building capital.
• Firms: Main purpose is economic. They satisfy needs of core stakeholders, such as employees (salaries) and shareholders (receive dividends and capital gains). Non-core stakeholders are also important. Typical economic operations are: buying and transforming input and selling output. Firms are for-profit organizations.
• State: Main purpose is non-economic (political, social, cultural). Divided in branches (territorial) and other entities (authorities, agencies, etc.). Core stakeholders: national community and state employees. Typical economic operations: production and consumption of public goods. It is financed by taxes and debt.
• Nonprofits: Main purpose is non-economic. Relies on volunteers and few employees.

Why is economic activity specialized?

Specialization: When different units carry out different types of activities, as opposed to when all units carry out the same activities. Economic activity is specialized by:

• Macro-classes: The fact that there exist four different social bodies that carry out economic activity.
• Within each macro-class:
• Families: A dominant type with variants.
• Firms: Different industries, different ownership, different size, etc.
• State: Different branches, different departments, different agencies, and authorities.
• Nonprofits: Different industries, different governance, different size, etc.
• Within each organization: The fact that groups or individuals within a firm perform different tasks.

What are the sources of specialization economies?

• Learning process: Repeating the same activity leads to developing manual dexterity, discovering more efficient ways to perform the activity, creating an inventory of problems and solutions.
• Individual skills: Specialization allows assigning tasks to those people who are most skilled at them.
• Technical and managerial orientation: Same mechanism as individual skills.
• Set-up costs: In the specialized solution workers perform always the same task, there’s no shifting from one to another, and this decreases the costs of shifting from one activity to another.
• Facilities and equipment: Specialized facilities and equipment are more efficient than generic versions. They also combine well with specialized work as specialized workers might have to run them, and it also lowers the amount of machinery needed.
• Job identification and motivation: Specialists tend to identify with their job and enjoy a sense of the command over the work situation. Mastery contributes to self-esteem if the task is hard enough to motivate the worker.

Specialization has its costs:

• Costs of coordination
• Cost of rigidity and specific investments: Specialized resources are less flexible than non-specialized resources.
• Demotivation: Highly repetitive tasks can reduce esteem and self-fulfillment

Benefits of specialization:

• Self-consumption is inefficient: Families are too small to achieve specialization.
• The absolute hierarchy is inefficient: Beyond a certain size, coordination costs are too high.
• Firms can take full advantage of specialization: Adapting their size and investments to all technical opportunities.
• Families have a room in the economy because they are natural social bodies.
• The state solves market failures (certain public goods can’t be bought/sold).
• Nonprofits solve state failures.

Class 3: What is a corporation? Stakeholder vs. shareholder views of the firm

The shareholder view

The shareholder view has been advanced forcefully by Milton Friedman -> “The social responsibility of a business is to increase its profits”.

Only people have responsibilities (i.e., businessmen) and not firms. An executive is an employee of the owners. His/her responsibility is to conduct the business in accordance with their desires. If executives pursue social responsibility, they spend the money of company owners for general interest. (= impose taxes on the firm) Executives should be chosen through a political process (elections). The doctrine of social responsibility is often a cloak for actions justified by self-interest. The doctrine of social responsibility undermines the foundations of society because it strengthens the view that the pursuit of profits is wicked, immoral, and must be controlled by external forces. This view was dominant in the ‘80s, it became less popular later due to increased public concerns with social and environmental issues.

The stakeholders view

Introduced by Edward Freeman -> “Businesses can be understood as a set of relationships among stakeholders”.

• Primary stakeholders: Those who are vital to the growth and survival of the firm. (i.e., customers, employees, suppliers, financiers, and communities)
• Secondary stakeholders: Those who affect primary stakeholders. (i.e., Government, competitors, consumer advocate groups, special interest groups, media)

This theory implies that the firms should satisfy all stakeholders. Unsatisfied primary stakeholders withdraw their contributions, while unsatisfied secondary stakeholders have a negative influence on primary stakeholders.

What does managing for stakeholders mean?

Managing for stakeholders requires a long-term perspective. Firms should have a purpose (= mission statement). Firms can’t put aside ethics.

Alternative processes for dealing with stakeholders:

• Do nothing
• Public relations approach: Managers try to convince the public by using communication, advertising, etc.
• Implicit negotiation: Take the position of stakeholders into account but do not interact or openly negotiate with them.
• Stakeholder engagement: Explicit negotiation with stakeholders.

Class 5: Opportunism, fairness, and cooperation: assumptions on the behavior of individuals and groups

Homo oeconomicus vs. human beings

Homo oeconomicus:

• Perfectly rational
• Clear objectives
• Able to compare alternatives
• All information available for free
• Individual preferences described by utility functions (isolation)
• Maximization of income/wealth
• No room for reciprocity, trust, and other emotions (opportunism)

This view is very useful for formalizing economic behavior and building economic models.

Human beings:

• Limits on information and cognitive ability (bounded rationality: individuals look for satisfactory solutions to their problems, given constraints on time, information, and resources. Expectations drive initial search, but are adjusted according to results until a solution appears acceptable)
• Members of groups, which shape their preferences and behavior
• Pursue well-being
• Emotions and propensity to cooperate behavior

Behavior and decision making in groups

Many organizational activities are carried out in social groups (= elementary social bodies). Social groups generate roles that drive behavior. The behavior of members is performed in the social groups. Each member has expectations of other members and him/herself. Each person has a role. Groups take decisions:

Garbage can model:

• Decisions are the outcome of independent streams of events within a firm.
• Consequences of the garbage can model:
• Solutions are proposed for problems that do not exist.
• Choices are made that do not solve the problem.
• Some obvious problems are never solved, because they compete for attention and resources with others in the same can.

Theory X and theory Y

Cooperation is useful but it creates organizational rents and residual results (= what remain of a firm’s revenue after resources are remunerated fairly). Cooperation requires trust among workers. Free ridership is possible when participants can limit their efforts without losing their share of the rent. This can have a positive outcome - if individual contributors are clear - or negative if individual contributors are not clear.

Class 6: Governance and management: Agency theory in different contexts. Corporate Governance mechanisms to protect shareholders’ interests.

What is corporate governance?

Corporate governance: “Systems by which companies are directed and controlled” “it is the framework by which the relationship among management, board of directors, controlling shareholders, minority shareholders, and other stakeholders are balanced.”

Companies: Legal entities made up of an association of members. Members share resources for economic activity.

• Partnerships:
• Used by small businesses.
• Unlimited liability of members.
• Partners matter as they deal directly with stakeholders.
• Difficult to transfer ownership.
• Decision by majority or consensus of partners.
• Possible corporate governance problems: Personal conflict.
• End when partners quit/die.
• Corporations:
• Large firms.
• Limited liability of members (shareholders).
• Legal personality of the company.
• Easy to transfer ownership (shares).
• Decision-making given to managers.
• Live as long as there are resources.

What is agency theory?

Describes principal-agent relationships:

• Principal: Shareholders
• Agent: Managers

It gives the agent the power to perform a service for the principal. Shareholders appoint a board of directors, and they appoint and monitor top managers. Small shareholders usually sell shares when they are not happy with managers in a firm. The board of directors collects proxies (= authority to represent them) from existing shareholders who are not interested in control and propose directors. When things go badly, the boards intervene before shareholders could form coalitions. Separation of ownership and control is mainly a US and UK phenomenon. Family firms have no separation.

Main responsibilities of the board:

• Strategy formulation
• Policy making
• Accountability to shareholders
• Supervision of managers

Problems with the agency relationship:

• Type I agency costs: Arise because of conflicts between shareholders and managers. Managers enjoy advantages (managerial discretion, information asymmetries, compensation not strictly linked to performance) that put them in the position to pursue their own interests instead of the interest of shareholders.
• Monitoring costs: Are incurred by the principal. Cost of measuring, observing, and controlling an agent’s behavior.
• Bonding costs: Are incurred by the agent. To guarantee that behavior is correct, such as reporting and procedures.
• Residual loss: Costs incurred by the principal from divergent principal and agent interests despite the use of monitoring and bonding.

Sources of conflict:

• Moral hazard: Preference for personal benefit
• Earning retention: Preference for firm growth
• Time horizon: Preference for short term
• Risk aversion: Preference for avoiding risk, or for taking excessive risk
• Type II agency costs: Arise because of conflicts between majority and minority shareholders.

How can agency costs be reduced?

• Board composition: Non-executive directors must monitor managers, and responsibilities of directors should be clearly specified.
• Concentration of ownership (blockholder): Reduces managerial discretion, but risk of type II agency costs (very common in Europe).
• Active ownership: Investors who try to use ownership rights to change managers’ behavior.
• Incentives: Connect managerial pay to outcomes.
• Control mechanism: Internal/external auditing, financial market regulations.
• Reputation: Name and shame managers who behave improperly.
• Market for corporate control: The stock price of underperforming companies drops, making it easy for other companies or investors to buy them, concentrate ownership, and remove inefficient managers. (very important in the US)

Class 9: What is a business firm? Economic activities in organizations: functions and business areas

What is the difference between functional and business areas?

Functional areas:

• Sets of processes characterized by a common function and a specialized set of skills.
• The functional areas are: Operations, R&D, finance, management of non-core investments, tax management, insurance management, insurance costs.
• Organization: Organizational design, H&R.
• Information: Activities providing information for decision making.

Business areas:

• Set of processes related to the same product/market.
• Firms may have:
• One business area: mono-business firms (i.e., Ferrari).
• Multi-business areas: Multi-business or diversified firms.